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Pay down debt or pay into your RRSP?
RRSP/debt discussion with David Trahair
- We're right in the thick of RRSP season and the questions are coming in, so we'll get right to it ...
- Hi everyone, I'm here.
- We have savings to last a few months, which is slowly growing, no credit card debt and nothing owing on our LOC. But we do owe more than 200k on our mortgage. So should we focus on putting what little extra is left at the end of the month toward the mortgage or RRSP?
- Hi Marty. You are in good financial shape compared to many Canadians with credit card debt balances. The key to your decision is what rate of return you expect to get on your RRSP versus your mortgage rate. Many people don't know how well their RRSP has done and therefore can't make a good prediction of what it will do in the future. I tend to go with the pay off the mortgage option since it is a guaranteed rate of return. It also depends on your age - if you are in good shape to pay off the mortgage by retirement and have been doing quite well in your RRSP then continuing with the RRSP sounds fine.
- Hi David, I have a Home Buyers Plan that I need to repay. Is there any reason why I shouldn't put all of my RRSP contributions against the outstanding HBP.
- Hi gmac. With the RRSP Home Buyers' Plan you are required to pay back the amount you took out (after a one year holiday) over the next 15 years. If you make any RRSP contribution the amount up to the 1/15th will be deemed a payback of the RRSP HBP. If you don't make a contribution CRA will add the 1/15th to your taxable income so you will essentially be paying back the tax refund you originally got on the RRSP contribution.
- and gmac, I don't really see an advantage to speeding up the payback unless you are quite sure your RRSP will do very well wrt the rate of return.
- Emman is asking about a situation that is typical for many: whether to continue contributing to an RRSP with credit card debt and outstanding loans ...
- I have about $10,000 of credit card debt and about $10,000 in student loans. Does it make sense contributing to RRSP while holding on to these debts?
- Emman. I don't think so. The rate on your credit card debt is probably 10%+ I am guessing. It is very difficult these days to make a rate of return anywhere near that on any kind of investment consistently. Remember, the absence of a cash outflow is as good as a cash inflow especially if the cash inflow is taxed. In other words if the interest in your credit card at 10% is $1,000 you'd need more than $1,000 in income to be left with the same money after-tax. Personally I would focus on the credit card and then the student loans before RRSPs.
- Reader CP has credit card debt at an even higher interest rate, and is wondering about taking even more drastic action - withdrawing from his RRSP ...
- What do you think about withdrawing $30,000 from my RRSP to pay off credit card debt costing 20% interest. My marginal tax rate is high at about 40% so I understand this will cost lots in tax. However, at 65, I want to just get rid of this debt. Not able to get consolidation loan either and I am still working at about 50k / year and plan to contribute for a a few more years. Your comments?
- Hi CP. That is a tough one. Personally I resist the idea of withdrawing from an RRSP especially when you are in a relatively high tax bracket. That's $12,000 in tax you would lose - I think that's too big a hit, although you are spending $6,000 a year in interest so it's at least debatable. I would instead stop contributing to your RRSP going forward and pay off the credit card debt. I would also try shopping around for a credit card balance transfer offer from another financial institution if you can to reduce the 20% rate in the meantime.
- Please note that not all credit cards charge are 10-20%. I was just approved for the MBNA Platinum Plus Mastercard which offers 0% for 10 months. Doesn't it make sense to transfer debt on a card like this, contribute to the RRSP, get a big tax refund and then repay part of the debt?
- Hi Taras. Agreed - offers like this one make a lot of sense. The key of course is also the person's habits - what led to the credit card balance in the first place? If they continue spending more than they make they may end up with balances on the new low rate card and also the original one. If the person gets the spending under control, your idea may make some sense but remember even at 0% you'll still have to pay back the amount of the debt itself somehow.
- And what about the term of the 0% interest rate, David? Taras says it runs for 10 months, so after that it's going up - who knows how high.
- Hi David. Do you advocate RESP over RRSP contributions in light of the 20% grant on the RESP? We have 3 kids and contirbute $300 per month to RESP. Should this be going to RRSP instead?
- Good point Ian. I think that is one reason why the financial institutions make offers like this that will cost them money in the short term. They know that people have a tough time changing their habits and are unlikely in a position to pay off the credit card after the low-rate term expires. And then they are the financial institution earnings 10-20%
- Hi David, We are 28 & 29 and have 3 kids. Home value of $550,000, Mortgage of $375,00, RRSP of $15,000, RESP of $5,500, Car Loan of $14,000, and savings of $16,000. Do you recommend RRSP, RESP, TFSA, or debt reduction in light of this informatio? Thanks
- Hi Dan. That's a really hard question and depends on the circumstances. My gut feeling is that the 20% CESG is too good to ignore so I would tend to favour the RESP. The RESP rules are also better now wrt flexibility in withdrawals if the student doesn't go to a University. There is also the benefit of the tax on earnings and grant portion being in the student's hands usually at a low rate or even zero upon withdrawal.
- Here's a video of The Globe's Rob Carrick and David Trahair talking about how people get into so much debt.
- Hi David, how about the tax return on RRSP? Let's say I have $10,000, if I buy RRSP, I get 2,000 tax return. If I use the amount to pay my mortgage, I won't get that much savings on interest, will I?
- In this video The Globe’s John Heinzl weighs in on whether people should pay down their mortgage or contribute to an RRSP.
- Hi Dan. You don't say what your incomes are which is key, but it would seem since you have no high interest consumer debt and are probably on schedule to pay off the mortgage, that RRSP or RESP contributions make sense. If you are in the top income bracket that would favour the RRSP route. I would also consider using some of your savings to contribute to a TFSA to shelter any income earned and to use it to top up the RESPs. One last point - if you do pay off the mortgage ahead of retirement, resist the urge to upgrade to a bigger house and get back into a big mortgage as a result!
- Hi Dan. Well you won't immediately but the tax refund is a deferral not free money - you'll eventually pay tax upon withdrawal of the RRSP funds. It also depends on how well your RRSP will do versus the mortgage in the future and that is hard to predict. It may not be an exciting option, but the guaranteed interest savings on paying off the mortgage is the safe option. As John Heinzl said in his excellent video on this subject - he's never heard anyone who paid off the mortgage that regretted the decision - and neither have I. That is what financial freedom is.
- We've only be able to get to a fraction of questions today, but it looks like the clock has run out on us. David, is there any one thought you'd like to leave readers with as they mull whether to make an RRSP contribution this year?
- Sure Ian. Keep in mind what objective #1 should be over the long-term; Aim for total debt-freedom by your retirement date including no mortgage. That won't be easy to do for most people but it is the best position to be in financially heading into your golden years.
- Thanks for joining us today, David. Some of the questions we didn't get to today and dealt with in Globe Investor's RRSP site.
