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RRSP vs. Mortgage Paydown

Some people feel it's better to pay down their mortgage than contribute to their RRSPs. While reducing your mortgage quickly makes sense, you should recognize that you'll need a significant nest egg to retire comfortably.

Fortunately, there's a way to accomplish both goals at once: contribute to your RRSP and use your tax refund to increase your mortgage payment. You'll be building your nest egg and reducing your mortgage at the same time!

Is it better to pay down your mortgage or contribute to an RRSP?

Certainly, every situation is different, and mortgage rates change over time, but consider the following example: Assume a 42% marginal tax bracket and maximum RRSP contribution room of $12,000. Tax savings from the contribution would be approximately $5,040 annually, which equates to about $420 a month in new money that can be applied to the mortgage.

Now let’s assume that the $125,000 mortgage is amortized over 25 years and that the average interest rate over the period was 6%. Monthly payments are $799.76. If this is bumped up by the $420 a month in tax savings from the RRSP, the taxpayer cuts the amortization period by 13 years. The results are the following:

  • The accumulated tax-sheltered earnings on the growth of the annual $12,000 contributions over 12 years (compounding at a before-tax rate of return of 6%) amounts to about $214,600.
  • Interest savings on the reduced amortization period of 12 years, instead of the original 25 years, equals approximately $65,300.
  • Total accumulated principal and earnings in the period will produce net worth of $214,600 in the RRSP and $125,000 in home equity, plus a further $65,300 in interest savings, for a total of $404,900 - all from an investment of just $144,000 ($12,000 x 12 years).


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