Q: I just bought a new house. I have a $250,000 mortgage at 2.97%. We have a little over $2 million in investments, but they are all in RRSPs in fairly conservative investments. Last year we made 7% and this year made probably 5%. We are in our early 50s and still working. Is it better to pay off the mortgage and take the tax hit or pay the mortgage and hope I make more on my investments? I can’t seem to get my head around it.—Darby
A: The mortgage versus RRSP debate takes many forms, Darby. Often people ask about whether to use their cash flow to either pay down their mortgage or put money in their RRSP. Your question is a little more extreme: cashing in your RRSP to pay off your mortgage.
Let’s start by reviewing some of the considerations:
First, here are some very general reasons to consider paying down your mortgage instead of contributing to your RRSP, subject to other factors:
-You are risk averse: Paying down debt provides you with a guaranteed rate of return via the interest you avoid thereafter—a return that will increase as interest rates normalize.
-You are not knowledgeable about investments: Paying down debt means you have fewer investments to worry about.
-You have a high debt level: Paying down debt may be a good idea to get your debt ratios in check.
-You are in a low tax bracket: RRSP contributions may provide little to no tax benefit and may eventually cause a clawback of government pensions in retirement.
-You have a spouse in a higher tax bracket with RRSP room: Take advantage of your spouse’s RRSP room before your own, even if they contribute to a spousal RRSP on your behalf.
All that said, Darby, you are considering more than just using cash flow to go towards your mortgage or RRSP. Withdrawing from your RRSP has different implications.
When you make an RRSP withdrawal, there is withholding tax on that withdrawal. The tax rates are 10% on a $5,000 withdrawal, 20% on withdrawals between $5,001 and $15,000 and 30% on withdrawals over $15,000.
But it doesn’t stop there. The withholding tax is just the beginning. You have to add your RRSP withdrawal to your income and pay tax accordingly. It may exceed the amount of the withholding tax. The all-in tax could be as high as 50% depending on your province of residence.
Generally, I’d advise against taking RRSP withdrawals to pay your mortgage, unless it was a case of being unemployed and unable to pay your regular mortgage payments otherwise. And even then, that would only be after exhausting non-registered investments, TFSAs and potentially other credit.
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If we ignore the complexities of income taxes, if you can earn a comparable rate of return on your investments as you’re paying on your debt, you might be reasonably indifferent between choosing one over the other to focus on. But the tax hit from withdrawing from a tax shelter like an RRSP is significant and should generally be avoided during your working years.
Giving up a mid-single digit return on your RRSP to avoid a mid-single digit interest rate on your mortgage is almost a wash—but if you only have 50 cents on the dollar left over from an RRSP withdrawal, it’s a less appetizing proposition.
I’m in favour of taking early RRSP withdrawals prior to age 72, but would generally consider this only after you have retired and have more modest sources of income otherwise.
With $2 million in RRSPs in your early 50s, you may need to consider how you allocate cash flow amongst your investments and mortgage going forward. I’m a firm believer that an RRSP can be too large. And when you do retire, you should develop a retirement plan to smooth out your income in retirement and maximize your government benefits, while also minimizing your lifetime income tax.
In much the same way I’d advise against withdrawing from RRSPs to pay down your mortgage, I’d urge you to try to avoid short-sighted goals in favour of the long run.
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.