That mortgage on your back? Relax. Here’s why

You need to take a hard look at your finances this weekend to determine whether you should be making your RRSP contribution before Monday’s midnight deadline.

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A CIBC poll out this week found that more than half of Canadians will not contribute to their RRSPs for the 2014 tax year. In fact, when Canadians were asked whether, if extra funds were available, they would contribute to an RRSP or pay down debt, 72% of respondents favoured debt repayment over retirement savings.

The primary reason was simply wanting the financial freedom of being debt-free. This emotional rationale outweighed more practical reasons, such as concerns that interest rates may go up.

The findings support earlier research by CIBC deputy chief economist Benjamin Tal that found Canadians are taking advantage of current low interest rates to pay down $11 billion more a year in principal on their mortgages than previously thought.

With mortgage interest rates at record lows, neglecting long-term savings in favour of debt repayment may result in sacrificing the quality of your retirement.

The decision to invest in an RRSP or, for that matter, a TFSA, or pay off debt boils down to a mathematical question: Can you get a higher rate of return on the investments in your RRSP portfolio than the interest rate on the debt, given a level of risk at which you’re comfortable?

If so, then investing is the better bet; otherwise, paying down debt is the best choice.

For consumer debt, such as credit cards and personal loans, the interest rate can be quite high, often approaching 20%. Since it may be difficult, if not downright impossible, to get a higher rate of return on investments with a reasonable amount of risk, it almost always makes sense to pay off this kind of debt before making an RRSP/TFSA contribution.

On the other hand, mortgage interest rates are at their lowest point in over 60 years. Consequently, if you have low-rate debt, it might make sense not to aggressively pay down that debt and, instead, contribute to an RRSP or TFSA if you can generate a higher rate of return.

Of course, investing in the bond or equity markets (as one might do within an RRSP or TFSA) cannot be compared to paying down a mortgage, which is more similar to a risk-free investment such as a Government of Canada bond. For Canadians with high levels of debt who would not be able to sustain an increase in mortgage interest rates, you should minimize risk and focus on debt repayment.

But if you’re willing to tolerate some risk in your investment portfolio while saving for longer-term goals, such as retirement that may be 20 or 30 years away, choosing to invest via an RRSP (or TFSA) may result in more money at the end of the day.

Jamie Golombek |  CPA, CA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Wealth Advisory Services in Toronto. | February 27, 2015

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