Best of: RRSP or Mortgage
Busy week again, here is a piece from last year asking that ever present question:
RRSP or Mortgage?
After last week’s “show and tell” about Mortgage worksheet calculators, the next question to ask yourself is which is more important to pay into your Retirement Fund (RRSP or 401k) or pay off your Mortgage (and debts)? Since the U.S. model has tax implications for paying off your Mortgage, and I do not wish to mention the Smith Manoeuvre for Canada, let’s just concentrate on the Canadian model.
In a lot of cases this question is of no real value since a lot of people can only afford to pay for their living expenses and do not have free money to pay for their retirement or speed up their debt payments, for those folks, the job is hard enough, but I encourage you to find savings somewhere and do something more with your found money than “party” with it.
Arguments For Paying Down Mortgage
Some of the reasons I have heard and espouse for paying down your mortgage first would be:
- Carrying debt is dangerous no matter what the economic times, and the sooner debt is removed from your plate, the sooner you can relax about your finances.
- Once your mortgage is paid off then you can start saving for your retirement, knowing that you will not have that expense in your golden years.
- Paying off your Mortgage is like investing in Real Estate, which is usually a good investment.
- I don’t view my house as an investment, I view it as an essential of life, as in shelter is somewhere you live, not where you invest.
- You are increasing your liquidity, by having more credit available to you, in case of emergencies.
Arguments For Retirement Money
The reasons to put money in your retirement funds are many as well:
- Retirement saving is like Golf, the sooner you start doing it the better you will be at it later. Money saved at age twenty has much longer time to double than money invested at age 50.
- With current interest rates, you can invest your money and make more with it, than if you pay off your Mortgage (typical Mortgage rate is about 6% whereas the Stock Market’s normal rate of return is about 7%, so you are ahead in the game).
- You get tax money back for putting money in your RRSP, but you don’t if you put that same money into your mortgage. This is important since the major expense for most of us, is still taxes.
Best Choice?
That would be telling, I’ll write some more about this tomorrow, but I am open to discussion, pointers to good articles, and any other comments folks might have about what the right choice for them was and is (remember at the end of this, it is a personal choice on your part).
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October 15th, 2009 at 9:44 AM
I’ve always been of the opinion that the mortgage is better unless you do something useful with your tax money, like invest it or pay off debt.
If you chose the RRSP option, and buy a big screen TV with your refund, you would have been better off just paying down the mortgage and saving your interest money. Of course, then you also wouldn’t have a big screen TV either . . .
October 15th, 2009 at 9:48 AM
My response is the same too. Your savings on the mortgage payout is far greater than the nominal 6%, as you have to earn far more before taxes to make the mortgage payment.
“I think David Ingram sums it up nicely in this document: http://www.centa.com/CEN-TAPEDE/2003/expert/expert119-01.html
Basically, every $1000 you put on your 6% mortgage saves $60 after taxes in perpetuity. In my case, I would have to earn about $120 before taxes to pay that $60, so the payout of the mortgage becomes a bargain.”
DAvid
October 15th, 2009 at 11:41 AM
Any argument based on “normal stock market return” is guaranteed BS. Retail investors generally won’t get the market return (active investors may beat it, with a bit of luck, but your standard retirement saver will not).
This is because you can’t just buy an index. You buy a fund (either traditional mutual fund or ETF), that has an MER and tracking error. On top of that, few people, if anyone will go 100% equity…probably wise decision.
And even if you managed to get those typical stock market returns, you got it through sheer luck. Paying down your mortgage gives you a guaranteed return of 4-6% (depending on your interest rate). Any stock market return will be lower on a risk-adjusted basis.
Not to say you shouldn’t save for retirement. I do. But I do it because it feels good, not because it’s more sensible.
October 15th, 2009 at 11:13 PM
I have a simple opinion on this. If your guaranteed after tax rate of return on your investment is better than your mortgage rate then investing is better. In most cases it will be unlikely that you can get a better guaranteed after tax return from investing.