Q: I have an outstanding mortgage of $490,000 with a 3.34% fixed interest rate for another 4 years and I do biweekly payments of $1,310.I currently invest $1,000 a month in a TFSA account that has given me an average of 8% last year, with a combined MER of 2.8%. I also have a group RRSP where I put in $690 and my employer puts in $200 a month and it has given me a return of 8% last year with the MER at 2.4%. Our household income is $150,000 a year and we have no other debt. My plan was to drop my TFSA and start paying down my mortgage faster for I do not feel that when the times come to renew my mortgage in 4 years that I can get the same rate. I have another $500 a month on top of the $1,000 from the TFSA that I could pay extra to my mortgage as well, so a total of $1,500.—Martin
A: Given where interest rates stand today, Martin, your rate seems kind of high. The banks are lending now for five years at a fixed rate of 2.89%, so your 3.34% doesn’t seem so great in comparison. But in an historical context, your rate is very low and you’re right to think that you might be at a higher rate at renewal in four years. Sub-3% interest rates are likely a short to medium-term phenomenon at best.
The recent drop in oil prices has taken some wind out of the inflation sails and caused rates to drop and talk of 2015 rate increases to all but disappear. Today’s mortgage borrowers need to anticipate a higher rate environment if they have more than say five years left on their amortization because their mortgage will very likely be outstanding and accruing interest at higher interest rates in the future.
You’re currently on about a 19 ½ year amortization to repay your mortgage. But if rates rise to 5% at renewal and stay put for the balance of your mortgage, it will take about an extra three years to pay if off. So I think it would be wise to consider your long-term debt repayment targets to ensure you’re on track to pay off your mortgage by retirement in light of how higher rates will push out your repayment period.
In theory, investing should win out over debt repayment in the long run. The TSX has returned about 9.5% annually over the past 50 years and the Bank of Canada prime rate has averaged about 8% annually. If you’re investing in an RRSP, you get the added benefit of tax refunds to help support investing as a better choice.
From my perspective, the big knock on your strategy is the brutally high fees. An average 2.8% MER on your TFSA investments is highway robbery. And the 2.4% group RRSP MER is something your company should be concerned about. If they’re placing a large volume of investments with a third party provider, they should be getting a bulk discount and ideally the investment choices available to employees would be below average MERs—not above average. They have a fiduciary responsibility to you guys that they are not fulfilling.
You’re only contributing about 7% of your family income to RRSPs currently, including your employer matching contributions. Given you’re accruing RRSP room at 18% of income each year, plus you may have past contribution room, I’d probably consider increasing your RRSP contributions at the expense of TFSA contributions.
I think TFSAs are a good tool, but far too often I see people contributing to their TFSA simply because the account is available. If you are in fact investing your TFSA to fund your retirement, there’s a good chance the tax refunds from RRSP contributions should be compelling you to opt for RRSP over TFSA. Depending on your province of residence and how much of your stated family income is yours versus your spouse’s, you’re probably paying a marginal tax rate of between 30% and 45%, with corresponding RRSP refunds to be generated accordingly.
Make sure you’re taking full advantage of the company match on your group RRSP contributions. That’s free money. So ensure you are maxing out there.
Your plan to drop TFSA contributions and pay down your mortgage isn’t a bad one. In the long run, RRSP contributions may be a better option than your mortgage or TFSAs, especially if you can get your fees down a bit with a different mutual fund choice like an index fund. Group RRSPs usually have passive options like index funds; 2.4% for an active fund is a big bite.
So without having all the facts and building a comprehensive retirement plan, my general advice would be to consider a combination of additional RRSP contributions and mortgage repayment with your extra cash flow instead of TFSA contributions. If you have accumulated money in your TFSA, you might even consider using it to making a catch-up RRSP contribution or putting it against your mortgage.
A long-term retirement plan can help you make projections and determine targets for debt repayment and annual savings. These targets can help keep you on track for becoming debt-free and accumulating sufficient retirement savings by retirement to fund your retirement expenses. You can also test assumptions around the RRSP versus debt repayment debate as well as RRSP versus TFSA with perspective.
Ninety per cent of the battle is ensuring that your expenses are less than your income and based on all of your extra cash flow, you’re doing a good job, Martin.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.