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Debt (Photos.com)
Debt (Photos.com)

Retirement and RRSPs

Pay off your debts, but don't sacrifice a good retirement Add to ...

It is safe to say people are paying more attention to debt and, perhaps, even paying it down. That might be because of the regular reports from Statistics Canada declaring we have hit another record for household debt, or the warnings from the Bank of Canada about impending higher interest rates.

All the attention on debt shows up in the Canadian Imperial Bank of Commerce’s annual survey of Canadians’ financial priorities. Paying down debt was cited as the top goal for 17 per cent of those polled, up from 14 per cent in 2011. Seven per cent said their primary focus is retirement planning, down from 13 per cent two years ago.

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The results beg the question: Are many of us sacrificing a comfortable retirement by focusing on debt reduction today? Or are we opting for a wiser strategy by chipping away at the sure thing, while fixed-income returns are near rock bottom and stock gains are uncertain at best?

The right mix of debt and retirement savings depend, it turns out, on your individual situation. “The first thing you should look at is expected rates of return and also your investment profile,” said Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth Management in Toronto.

While soaring home prices are one of the factors behind ever-higher household debt numbers, having a large, long-term mortgage at today’s very low rates may be unsettling for some, but it should not be a concern if it is the main debt people hold. “If you have a relatively low mortgage rate, perhaps you could do better by [steering] any excess cash toward long-term retirement savings if you expect to get a higher rate of return than what you are paying on your mortgage,” he said.

That is, if the individual has no debt such as credit card balances or other personal loans that carry a higher interest rate than mortgage debt.

The CIBC executive noted that a mortgage holds an almost identical risk profile as fixed-income investments, as both are priced off the rates of long-term government bonds. So if you are an investor who favours the guaranteed return of fixed-income products in your registered retirement savings plan and you have a mortgage, you would probably be best advised to stick to paying down the house loan.

The new year is a time when people zero in on three aspects of their lives, their weight, their health and their money, said Susan Howe, a regional financial planning consultant with Royal Bank of Canada Financial Planning who works in southwestern Ontario. For her, any decisions regarding where to direct extra money begins with an analysis of household cash flow. “What do I have to help me to apply to either savings or to debt depending on what my objectives are?”

Ms. Howe said the majority of her clients opt for a mix of debt, short-term savings and long-term retirement savings. “How you save sort of depends on the timeline you have to save for it.”

The RBC executive worries that there may be too much attention paid to Canadians’ increasing debt load. “Not all debt is bad. If you have a mortgage and are building equity in the home, then that likely is a good debt to have.” High levels of consumer debt, particularly credit card debt carrying double-digit interest rates, should be considered bad debt.

Ms. Howe advises people to list their debts and the interest rates that they carry to determine which ones to pay down first (starting with the most expensive). Most bank websites have loan calculators to help with the process. Some may also consider seeking a loan consolidation from a financial institution that allows them to put all their consumer debt in one large pile and ultimately save on interest costs. While loan consolidation can simplify the debt picture and make it easier to manage cash flow, it comes with the risk, as some may feel the urge to run up balances again on those paid-off credit cards.

The tried and true strategy of putting money in your RRSP to generate a tax refund and using that money to pay down debt should be considered seriously, said Ted Rechtshaffen, president and chief executive officer of TriDelta Financial of Toronto. “The big issue is how much is the interest rate [on the debt] and how much is your tax refund going to be?”

The financial adviser recently completed an article for clients tackling the question of when people should sock away money into a RRSP. It comes down to whether you get a better bang for your buck today by sheltering that income from tax compared to some future date. “Is your income high enough today, first of all, and second will the tax refund you get be the same or higher than the tax bill you get when you take it out?” For those anticipating a major windfall such as a large inheritance down the road, making major sacrifices today to build a large RRSP nest egg might not make a great deal of sense.

Mr. Rechtshaffen sees little urgency for people to attempt to pay down their mortgages as quickly as possible. “If you are paying under 4 per cent on a mortgage, you do have to ask yourself how valuable is it to pay off that debt quickly.” Still, paying down debt is a guaranteed after-tax return, so eliminating a chunk on your mortgage will provide an after-tax return of 3 to 4 per cent, he allowed.

Your income also needs to be factored into the debt-versus-savings question, he said. “If your income is $150,000, I would definitely be putting money in your RRSP first and getting [a] 46-per-cent refund this year in Ontario before worrying about paying down a 3-per-cent mortgage. You want to take advantage that you are in the highest tax bracket and every dollar you put in an RRSP” reduces your tax bill.

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