Saving for retirement beats paying down your mortgage.
There – a long-standing debate in Canadian personal finance is settled. To build wealth in today's low interest rate world, divert money you were going to use to pay down your mortgage balance to your registered retirement savings plan or tax-free savings account.
This is the conclusion of a report to be issued Thursday called "Mortgages or Margaritas: Is Paying Down Debt Putting Your Retirement at Risk?" Writer Jamie Golombek, managing director at CIBC Wealth Advisory Services, estimates that adding to your retirement fund instead of paying down debt can in some cases make you richer by tens of thousands of dollars.
There's a rule that guides the mortgage paydown versus retirement investing debate: If a realistic investment return in an RRSP or TFSA is higher than the interest rate on your debt, then you're better off investing. With mortgage rates falling from already low levels in 2015, the investing advantage over a mortgage paydown has never been more pronounced.
"We have the lowest interest rates we've seen in our entire lives, and yet we see people focused, obsessed almost, on paying down debt," Mr. Golombek said. "Yes, it's comfortable and easy. But at the end of the day, is it short-sighted?"
Mr. Golombek is right on the money about the attention being paid to paying down mortgages and other debt. In a new poll from Canadian Imperial Bank of Commerce, 72 per cent of participants said they would choose paying down debt over adding to their RRSP if they had extra money available. Google Canada reports that searches for "pay off debt" were at a record high in January – up 9 per cent over the same period of 2014.
Finally, debt was far and away the topic raised most often by recruits in The Globe and Mail's financial boot camp we ran last week (catch up online here). Our rush to pay down our debts could very well be a sign of borrower's regret. At least subconsciously, we recognize we've borrowed too much.
The focus on mortgages and other debts may also be a sign of the discomfort some people feel about investing in the stock market. Paying down debt is a guaranteed benefit, while even well-diversified portfolios of stocks and bonds can be unpredictable.
All of the emphasis on mortgages and debt is not a mistake so much as it is a missed opportunity. Getting out of debt sooner means you waste less money on interest and arrive sooner at the point where you achieve the financial flexibility of being debt-free. But Mr. Golombek makes a good case for the financial benefit of putting extra money into retirement.
His key assumptions are that you have $2,500 in extra pretax funds per year, that you can achieve a long-term average net return after fees of 6 per cent from a balanced portfolio, a 3-per-cent mortgage rate and a 30-year time horizon.
At a marginal tax rate of 30 per cent both in your working years and in retirement, the invested funds would add $146,700 to your net worth after 30 years. Paying down mortgage debt would provide a benefit equivalent to $85,800, or $60,900 less than putting money in the RRSP or TFSA. If you move into a 20-per-cent marginal tax rate in retirement, the RRSP benefit rises to $167,700 and the TFSA benefit remains at $146,700.
Mr. Golombek said these numbers point to a rule for choosing between RRSPs and TFSAs. If you expect your marginal tax rate in retirement to be higher than it is when you're working and saving, then TFSAs are more attractive than RRSPs.
Putting extra money into retirement savings instead of a mortgage is a clear win in many cases, but other forms of debt are a different story.
Credit cards have rates of close to 20 per cent – if you carry a balance, ignore retirement for the moment and pay it down. Loans and some lines of credit may also have rates that exceed what you can get from investing.
A few other caveats in the debt versus RRSP argument:
-Stock market risk: Retirement saving only wins when you have some exposure to stocks.
-Time horizon: 20 years or more is best.
-Overall debt levels: If you can just barely pay what you owe, reduce your debt load and hold off on retirement saving.
Coming up in a column next week: Why choosing retirement over the mortgage is especially important for young adults.
