Should you pay off your mortgage or invest in a TFSA or RRSP?
Your choice can shape your financial future. While emotions play a role, let’s dive into the numbers to see the impact!
To make an apples-to-apples comparison, you invest $15,385 in your RRSP. To reach that amount, you borrow $5,385 from a financial institution for 2 to 3 months. You’ll pay around $100 in interest, bringing your total RRSP investment to $15,385. With a 35% marginal tax rate, your RRSP refund will be $5,385, which you can use to repay the loan.
Scenario 1
a)The same tax rate before and after retirement b) The interest rate on debt and the rate of return on RRSP/TFSA investments are the same.
Fast forward 10 years,
RRSP – Your $15,385 investment in the RRSP could grow to nearly $25,060. After taxes, this leaves you with $16,289.
TFSA – If you had invested in a TFSA instead, the withdrawal would be tax-free, so your ending balance would be similar i.e. $16,289.
Debt – A debt of $10,000 after 10 years would have a balance of the same amount of $16,289.
Who wins: You would have the same outcome whether you choose a TFSA, RRSP, or make a debt repayment.
Scenario 2
- Your pre-retirement tax rate is 35% and Your tax rate drops to 25% in retirement.
- The interest rate on debt and the rate of return on RRSP/TFSA investments are the same.
Fast Forward 10 years
The RRSP balance would be $25,060 pre-tax and $18,795 after-tax.
TFSA balance would be $16,289
The mortgage balance would be $16,289.
Who wins: RRSP would outperform your mortgage and TFSA, making it a better option. You could invest in an RRSP and pay off the debt after 10 years and still, you would have an extra $2506.
Scenario 3
a)Let’s assume a 7% return on your investments, higher than the interest rate on your debt. b) The tax rates before and after retirement are the same (35%).
Fast Forward 10 years
RRSP pre-tax balance would be $30264 and after-tax $19672
TFSA balance would be $19,672 and there are no taxes on TFSA.
The mortgage balance would be $16,289
Who wins: Here, investing will likely yield better results than paying off the debt.
Scenario 4
a)Your tax rate in retirement is 45%, compared to 35% pre-retirement. b) The interest rate is the same for debt repayment and investments.
Fast Forward 10 years
RRSP pre-tax balance would be $25,060 and after-tax $13,783
TFSA balance would be $16,289 and there are no taxes on TFSA.
The mortgage balance would be $16,289
Who wins: In this scenario, the TFSA and paying off your mortgage are better choices compared to investing in an RRSP.
Important: if you have high-interest debt, like credit card debt, it’s crucial to pay that off before investing. Beating a 20% annual return after taxes and fees is nearly impossible with most investments.
Disclaimer: This is for information purposes only.