Mortgage, RRSP or TFSA?

Paying down low-interest debt, such as a mortgage, can negatively impact retirement savings, says CIBC’s Jamie Golombek

By Tessie Sanci | February 19, 2015 11:00

Almost three-quarters of Canadians would prefer to pay down debt over adding to their retirement fund, according to a poll conducted for Toronto-based CIBC.

“The decision to pay down debt at the expense of retirement savings is often an emotional one that isn’t driven by logic,” says Jamie Golombek, managing director of CIBC Wealth Advisory Services.

More than half of Canadians, at 56%, say they want the financial freedom of being debt free while 20% believe they have too much debt and want to pay it off. Only 11% believe the interest rate on their debt is too high and prefer to repay their debt instead of investing into a registered retirement savings plans (RRSP).

Canadians who are paying down mortgages while interest rates are low may be depriving themselves of the benefits from investing extra money into an RRSP or tax-free savings accounts (TFSA), says Golombek.

This is if the individuals in question do not have a high level of debt, can handle an increase in mortgage interest rates and can tolerate some risk in their investment portfolio, he adds.

“Of course, if [someone is] holding high interest debt, paying that down is almost always the best choice,” says Golombek.

Golombek explains how paying down low-interest debt, such as a mortgage, can negatively impact retirement savings in his new report, Mortgages or Margaritas: Is paying down debt putting your retirement at risk?

The report illustrates the potential benefit of long-term savings in an RRSP or TFSA versus repaying debt under three different marginal tax rate scenarios. The three scenarios use the same basic assumptions: $2,500 per year in extra pre-tax earnings, a 6% long-term rate of return on investments in an RRSP or TFSA, a 3% interest rate on a mortgage and a 30-year time horizon.

If a Canadian who is within marginal tax rate of 30%, both at the time an RRSP or TFSA contribution is made and withdrawn, were to invest that $2,500 a year, the individual’s net worth would increase by $146,700 after 30 years. By using the funds to repay mortgage debt, the benefit would be only $85,800.

“In this example, you would be $60,900 further ahead in 30 years time by investing in an RRSP or TFSA every year, assuming a constant tax rate,” says Golombek.

As many Canadians expect to be in a lower tax bracket during retirement, their RRSP benefit could be even higher. For example, those who fall from a 30% to 20% tax rate can see their RRSP investment climb to $167,600, while the TFSA benefit remains $146,700 and the debt repayment benefit at $85,800. That makes the RRSP investment the better choice, he says.

If someone’s marginal tax rate in retirement is expected to be higher than when that person contributed to an RRSP or TFSA, the TFSA would be the more attractive option, according to Golombek.

Approximately 1,500 adult Canadians who are also Angus Reid Forum panelists were randomly selected to participate in this survey between Jan. 23 and 25.