TAX AND ESTATE PLANNER, TD WEALTH
Investing your spare cash versus paying down your mortgage is a classic financial conundrum for which there is no “magic solution.” Each situation is different, yet the starting point is the same: You are using after-tax money to invest or pay down the mortgage.
Here are a couple of quick assumptions. While employed, many of us will be paying off a home while continuing to save regularly for retirement.
So, let’s assume you’ve been conscientiously doing both. Next, without knowing your personal situation, I can only make general comments.
The case for paying down your mortgage
If you can make an extra monthly payment to the principal every year, it (very roughly) knocks three years off a 25-year mortgage.1
If you’ve seen the value of your home rise 100% in the past 20 years, you may wish to enjoy having fully paid off your home as soon as you can.
Taking a longer view, the sale of your principal home is an important consideration once it’s paid off. But accessing a gain on the sale of your home versus accessing the same amount out of your Registered Retirement Savings Plan (RRSP) will result in a different financial outcome.2 The gain on your home may be tax-free (because of the Principal Residence Exemption you receive, if you qualify) while the funds from your RRSP will be taxable at your marginal tax rate (in Ontario, the highest marginal tax rate is 53.53%). As with any large financial transaction, it’s best to consult a tax advisor for personalized advice.
So far, it appears paying your mortgage off faster can be a judicious decision.
However, one cannot ignore some basic financial planning guidelines, namely that of avoiding being house rich and cash-flow poor. Beware of paying down the mortgage while underfunding retirement savings.
It’s ironic how people know the month they will have their home paid off yet are unaware what kind of money they’ll need for retirement. You may be on track for retirement or you may be wildly off the rails but, unless you sit down with an advisor or do the appropriate calculations yourself, you may not know how much you should be saving.
The argument that your house is your retirement plan carries its own risks. Primarily, with all your money locked into a home, you have not diversified your retirement investments (i.e., your home is your only investment) and its value may fluctuate and fall short of the desired return needed. Further, once you do sell, you still have to live somewhere which will draw down your proceeds of the sale. With soaring house prices, it’s possible your next residence will be more expensive than you reckoned on.
The case for investing any spare money in an RRSP or TFSA
An RRSP is one way to help meet the financial needs of retirement. The past decade has been fruitful for investors. According to TD Economics, Canadian investors on the whole have experienced solid 5% to 7% annual portfolio gains, outperforming those of the previous decade.3 If you have been making steady RRSP contributions, who knows, your investment returns to date may have exceeded your financial goals and you can afford to move extra cash toward paying down the mortgage faster. Again, you should get a professional to make these calculations.
With an RRSP, your contributions are tax-deductible, meaning you can deduct the amount you contributed from taxable income. Applying the tax refund, if any, to your mortgage may be another option worth considering.
Compared to an RRSP, a Tax-Free Savings Account (TFSA) has some advantages.4Your investment grows tax-free but there are also no tax consequences when you withdraw the funds. Unless you are locked into investments like GICs, you could consider the funds in a TFSA to be more easily accessible than an RRSP (because of the tax consequences). You may also consider this strategy to help pay down your mortgage: You try to maximize your TFSA contributions every year, leaving some funds in liquid assets. If you’re happy that you have invested enough in your TFSA at year’s end, transferring some funds toward the principal of your mortgage can be helpful.
The flexibility of the TFSA helps because, if you feel you should invest more one year, depending on your investing strategy, the funds are generally accessible — you can always pivot back to your mortgage when you’re able. Because of the accessibility factor, this also allows the TFSA to be a place to park an emergency fund.
Get financial advice
The decision to pay down your mortgage or make increased registered plan contributions is not a simple one. It may be helpful to speak with a financial advisor to see which option suits your personal financial needs.
Sébastien Desmarais is a Tax and Estate Planner who assists business owners and high net worth families at TD Wealth with their tax, estate and business succession plans. Sébastien also helps clients with cross-border estate and tax-planning issues.
- Based on a 25-year mortgage of $400,000 paid back monthly with an interest rate of 3.25%. ↩
- The RRSP contribution limit for the 2021 tax year is $27,830, or 18% of the earned income reported on your 2020 tax return — whichever is less. Any unused contribution room from previous years is also carried forward. Pension adjustments may also impact the contribution limit. You’ll find your current RRSP contribution limit in your latest Notice of Assessment. ↩
- “James Orlando, “Canadian Long-Run Financial Market Returns” TD Economics, July 29, 2019, accessed Mar. 25, 2021. https://economics.td.com/canadian-long-run-financial-market-returns ↩
- The TFSA annual contribution limit for 2021 is $6,000. Annual contribution limit for 2019 and 2020 was $6,000 and from 2016 to 2018 was $5,500. Annual contribution limit for 2015 was $10,000. Annual contribution limit from 2013 to 2014 was $5,500. Annual contribution limit from 2009 to 2012 was $5,000. The annual TFSA contribution limit is subject to change by the federal government. Any unused contribution room from previous years is carried forward. ↩