Aiden is 25, single and the proud owner of his first home, a half duplex in Alberta. He’s enjoying his second career job, earning $85,000 a year in public relations. He previously worked for the government.
“I saved my salary while I worked from home and lived with my parents during the worst of the COVID-19 pandemic to make the down payment,” Aiden writes in an e-mail. He also emptied his tax-free savings account. He put 20 per cent, or $85,000, down on a house that cost $425,000 in 2021. With the improvements he has made, including a basement apartment, he thinks his house could be worth $550,000 now. He has about $323,500 remaining on his mortgage.
Should he pay off the mortgage or invest for the future?
“Traditional personal finance wisdom suggests I pay the house off ASAP,” Aiden writes. His mortgage rate is low – 1.74 per cent – but he is averse to debt and concerned about having to pay a higher interest rate when his mortgage comes up for renewal in 2024. He could probably earn a higher rate of return in stocks – or even a guaranteed investment certificate, Aiden adds. Should he use his surplus cash flow to pay off the house or invest for the long term?
He also wonders whether it is worthwhile to open a registered retirement savings plan (RRSP) given that he has substantial contribution room in his TFSA.
Long term, Aiden wants to retire at age 55 with lifestyle spending higher than he has now and enjoy the good life – skiing in the winter, concerts and travelling.
We asked Jason Heath, an advice-only financial planner at Objective Financial Partners in Markham, Ont., to look at Aiden’s situation.
What the Expert Says
Aiden has roughly a $250,000 net worth, which is pretty good for a 25-year-old, Mr. Heath says. Granted, nearly half of that has come from home price appreciation on the house he purchased in September, 2021. “He bought a house he could afford, he has an emergency fund in his TFSA, and he has monthly payments he can manage while continuing to save,” the planner says. “So good on him.”
Once Aiden is done paying off an interest-free loan from a relative for his student debt, he will have an extra $1,000 a month to use to pay down his mortgage or invest, the planner notes. “Aiden asks whether he should pay down his mortgage more aggressively but is leaning toward buying stocks.” If his 1.74-per-cent fixed-rate mortgage renews at an assumed 4.5 per cent in September, 2024, Aiden’s payments would need to rise by $455 a month to $1,855 to maintain the same amortization.
Some of Aiden’s mortgage interest is tax deductible because he rents out his legal basement suite, so this makes his cost of borrowing a bit less, Mr. Heath says. If Aiden thinks he can earn a higher rate of return investing in his TFSA than the borrowing rate on his mortgage, he may come out ahead by investing. “That said, the new normal of higher interest rates makes investing rather than debt repayment less compelling.”
In the long run, there may not be a compelling advantage to paying down his mortgage versus contributing to his RRSP or TFSA, assuming the mortgage interest rate and investment returns are similar. Both investing and debt repayment are good because they increase your net worth (net worth = assets minus liabilities). Aiden mentions being debt averse, so considering a lump-sum payment against his mortgage at renewal, or increasing his payments, should be considered.
Aiden has never contributed to a registered retirement savings plan. “He is just on the cusp of going from a 30.5-per-cent marginal tax bracket to 36 per cent, so this is the tax refund rate he could expect on his first dollar of RRSP contributions as an Alberta resident,” the planner says. It is likely he will withdraw money from his RRSP at a 30-per-cent tax rate in retirement, making RRSP contributions advantageous for him if his income continues to rise.
Once Aiden pays off his student loan later this year, he should consider directing at least some of his $1,000 of extra monthly cash flow to RRSP contributions, Mr. Heath says, “especially given he has a healthy TFSA balance of $30,000.”
Aiden’s budget seems light on planning for future home repairs and renovations, as well as an eventual car replacement, the planner says. In preparing his forecast, he added in $500 a month for each item to bring Aiden’s monthly expenses up to $4,045 a month, excluding debt repayment, saving and taxes.
Aiden’s $12,000-a-month desired after-tax spending in retirement is “way higher” than his current spending, adjusted for inflation, Mr. Heath notes. Even with the extra $1,000 a month added to his spending, assuming a 2-per-cent inflation rate, his current after-tax spending would be about $6,500 a month by his age 50. “It is not unreasonable to want to spend more in retirement, especially in the early years for travel, for example, but that’s nearly doubling his current standard of living,” the planner says.
Aiden saw his parents retire at 55 and would love to retire by 50 if he can. “I made some assumptions beyond the $4,045 per month of living expenses (including renovation/repair and car budgets),” Mr. Heath says. These include a modest 2-per-cent annual increase in his salary, bonus and basement rental income, 65 per cent of the maximum Canada Pension Plan benefit at age 65 (low because of early retirement), maximum Old Age Security, his small government defined-benefit pension at age 65 (adjusted for 2 per cent inflation from now until then), 6-per-cent returns on his self-directed stock portfolio, 2-per-cent inflation (as inflation subsides), and a 4.5-per-cent mortgage rate for the balance of his mortgage after the 2024 renewal.
“The result is his investments are projected to be depleted by about age 87 and he may need to borrow about 10 per cent of his home equity by age 95,” Mr. Heath says. “Obviously, if he wants to significantly increase his spending to his $12,000 after-tax monthly target, he will have to work way past age 50.”
Given Aiden’s current age and stage, and how much can change between age 25 and retirement, the main thing he can do is just maintain the good trajectory he is on currently. Life changes, such as a relationship or a family, could be material in his long-term planning, Mr. Heath says. Aiden may not always want a basement tenant either.
Because Aiden is financially dependent on himself, he should consider disability insurance, which he presumably does not have available through his employer, the planner says. “The odds of him becoming disabled are much higher than dying [prematurely].” A disability insurance policy that would replace Aiden’s income if he was disabled and could not work is an important risk-mitigation goal for him to consider.
The Person: Aiden, 25.
The Problem: Should he pay down his mortgage or invest for the future? Should he open an RRSP? Can he retire early?
The Plan: Consider opening an RRSP to take advantage of his unused contribution room. Monitor interest rates when deciding whether to pay down the mortgage or invest. Plan on spending much less in his later years if he wants to retire at age 50.
The Payoff: The rewards that come from good spending and saving habits.
Monthly net income: $5,150 (plus $1,150 gross rental income).
Assets: Bank account $1,000; TFSA $30,000; estimated present value of defined benefit pension $21,400; residence $550,000. Total: $602,400.
Monthly outlays: Mortgage $1,400; property tax $300; water, sewer, garbage $110; home insurance $150; electricity $100; heating $130; maintenance, garden $170; transportation $440; groceries $500; clothing $25; interest-free student loan to relative $1,000; gifts, charity $170; vacation, travel $250; political donations $100; dining, drinks, entertainment $400; sports, hobbies $50; subscriptions $20; health care $30; communications $100. Total: $5,445.
Liabilities: Mortgage $323,500; personal loan $7,000. Total: $330,500.
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Some details may be changed to protect the privacy of the persons profiled.
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