Happy Valentine’s Day to everyone 💖
Whether you’re celebrating or not, there’s nothing wrong with sending out the love (and chocolate…there is nothing wrong with sending chocolate). The bf and I are not big on Valentine’s Day, it’s rare for us to go out and we don’t exchange gifts. I find that restaurants are so busy and a lot of places do a ‘special’ menu for the night, which often doesn’t stand up to their usual fare. Instead, we stay in and cook dinner together. Sometimes it’s fancy, sometimes it’s meatballs and mashed potatoes (that’s tonight if you couldn’t tell, but we’re doing real potatoes, you know, cause it’s Valentine’s Day). Now onto the other big event in February….RRSP season.
February rolls around and all of a sudden everyone is concerned about making their RRSP contribution before the March 1st deadline. One quick note on that…it will make your life way easier if you set-up monthly contributions to your RRSP instead of panicking to get the cash together every February. RRSP season is a myth; it runs all year long (just like winter in Canada). Can we make a deal that you won’t be a last-minuter next year?
A common question I get asked is ‘Should I contribute to an RRSP?’ followed closely by ‘Should I pay down my mortgage or invest?’ Today I’m going to combine both those topics and determine if you should focus your money on your mortgage or your RRSP.
Ugh, math. Not my favourite subject, but I promise it’s easy stuff. The first thing you’ll want to determine is whether or not an RRSP is even right for you. To get the benefit of an RRSP you want to be making contributions when you’re in a higher tax bracket than when you withdraw the money. The tax refund can make it seem like an A+ idea, but when you’re in your low earning years, it doesn’t necessarily make sense. We won’t get into it here, but the one exception to that would be if you’re planning to use the first time home-buyer’s plan.
Alberta/Federal Combined 2017 Tax Rates
|Taxable Income (2017)||Marginal Tax Rate|
|first $45, 916||25.00%|
|over $45, 916 up to $91,831||30.50%|
|over $91,831 up to $126,625||36.00%|
|over $126,625 up to $142,353||38.00%|
|over $142,353 up to $151,950||41.00%|
|over $151,950 up to $202,600||42.00%|
|over $202,600 up to $202,800||43.00%|
|over $202,800 up to $303,900||47.00%|
Based on the Alberta tax table above, if you are earning $75,000 per year, you won’t see much benefit in using an RRSP unless your retirement income will be less than $45,916. If you stay in the same tax bracket, you’d be getting a refund at the 30.50% tax rate but then you’d be paying 30.50% tax when you withdraw. If that’s the position you’re in, you might want to look at investing in a TFSA instead. At least until your income goes up a bit.
Once you know that an RRSP is the right option, we need to figure out if the benefit of investing outweighs the benefit of paying down your debt. Neither is a bad option, but there will be one that’s better for you. To determine which we’ll need to look at interest rates.
If you have debt, you are paying the bank (or other financial institution) to lend you money. The opposite is also true. If instead, you are lending money to the bank they will pay you. Investing your money in the stock market is almost the same thing, but instead of the bank paying you for access to your money it’s other companies. We need to compare those rates to figure out if borrowing or saving makes more sense.
Credit cards (and other high-interest debt) will be a loss 99.99% of the time. If you have debt like that you always want to focus on paying that off before investing. You can get charged 20% interest on a credit card, and you will be hard-pressed to find an investment that consistently earns you that much.
Mortgages are different. Yes, they’re still debt, but interest rates have been at historic lows (but they are going up), so it’s not uncommon to be paying rates as low as 3%. With rates that low you have a good chance of earning a higher return on your investments over the long term. Right now, the numbers almost always favour investing over putting a lump-sum on your mortgage because of the low-interest rates. That’s just a snapshot though. If interest rates continue to rise the decision becomes less clear. The bonus of paying down your mortgage aggressively when rates are low is that more of your money goes to principal, saving you interest payments in the long term and shortening the length of your mortgage.
There is always a personal side to topics of money. Different people have different tolerances to risk; some are extremely risk averse while others are willing to shoot for the moon. Neither way is wrong, but forcing yourself into strategies you aren’t comfortable with is never the right call.
Debt is Risky
Even low-interest debt, like your mortgage, is risky. Consider how things would be if you had a sudden job loss? Would you still be able to pay your mortgage? Or would you be in a better position if you didn’t have a mortgage (or had a smaller mortgage? Obviously, the second choice is better. Fewer expenses mean less stress when money is tight.
There are steps you can take to lower the risk of a job loss such as having an emergency fund or diversifying your income streams, but nothing will completely eliminate the risk. What you need to figure out is if the risk is worth it to you. Does debt stress you out? If the answer is a strong yes, then paying down your mortgage is the right choice. Peace of mind is worth a few rate of return points.
What if I told you that you could do both; sounds pretty great right? We all know that contributing to your RRSP gets you a tax refund. Instead of spending that refund to go on vacation or re-investing it, why not use that to pay down your mortgage. It’s not going to be as much as if you had focused on your mortgage, but it’s still something, and something is better than nothing.
Let’s say you contribute $5,000 to your RRSP and your annual income is $75,000. That means your marginal tax rate is 30.50% so you would get $1,525 back when you file your taxes. That’s an extra $1,525 you can put towards your mortgage for the year. It might not sound like a ton, but every bit counts. If you put that $1,525 on a $350,000 mortgage with a 3% interest rate and a 30-year term, you would knock two months off your repayment period and you’d save almost $1,700 in interest. Tell me again how that $1,525 won’t make a difference?
There’s no right or wrong option when it comes to putting money towards your mortgage or your RRSP. Both are good options, and even though the math might point in one direction, you also need to weigh the emotional burden of debt. Risk tolerance is as unique as your fingerprints, and there’s no prize for being a daredevil. (Unless it’s the Olympics because those big air snowboarders win gold for being the craziest.)
Where do you guys focus your financial efforts? Are you more focused on getting rid of debt or building up your investments?
This post was proofread by Grammarly.