Choosing where to direct your savings can be challenging, especially with so many competing demands for funds. That’s why It's important to save up in a short-term emergency fund, as well as to invest long-term savings in your registered retirement savings plan (RRSP). But there are other options, too. For example, you can make extra payments on your mortgage now in order to save interest and payments down the line. But is that the best use of your money?
It's certainly a popular strategy. According to the 2019 Sun Life Barometer survey,* many Canadian homeowners are prioritizing paying off their mortgage. But about 20% say they’re still paying down a mortgage after they retire. That could be why the same survey found that fewer than one in five say that saving for retirement is their top financial priority. (*The Barometer survey measures Canadians’ attitudes about their health and finances.)
At the same time, prioritizing your mortgage at the expense of saving in other types of retirement accounts could leave you with a smaller nest egg at retirement time. Plus, you may have fewer options to manage day-to-day cash flow.
Wondering which strategy is best for you? Here are four questions to ask yourself as you consider your financial goals.
1. How long do you have until retirement?
The further away you are from retirement, the more important it may be to start saving for your retirement. That’s because the longer you have until you need to tap your retirement accounts, the more your money will grow, thanks to compound interest. That's the interest that is paid on interest – essentially, free money.
Say you contributed $1,000 into an RRSP and it earns 5% interest. This would give you an extra $50. (To do the math, multiply 1,000 by .05 and you’ll get 50.)
That means you now have $1,050 that is earning 5% interest. As you can see, those numbers will increase significantly the longer the money sits in your account.
- Are you saving enough for the future? Try this RRSP calculator to find out.
- Pay off debt or save for retirement? Here’s how to prepare financially for the future.
2. How much do you have left on your mortgage?
The closer you are to paying off your mortgage, the more tempted you may be to bump up those payments and be done with it once and for all. But the extra payments actually do the most good when you’re just starting out paying on your mortgage. That’s because you’ll be shaving down the amount of interest you’ll pay over the life of the loan due to, again, compound interest.
The same way it makes your investments accumulate faster, it also compounds your savings when you pay off more of your mortgage principal* early on. (*Your mortgage principal is your actual mortgage balance, not including the loan interest.) Doing so leaves a smaller sum to accrue interest from your lender.
- Do you need mortgage insurance?
- Mortgage protection includes life or critical illness insurance to help cover your mortgage payments if you become critically ill or die unexpectedly. Apply online and get a quote today.
3. Do you want to move or stay in your house when you retire?
Let’s say you’re planning to downsize or relocate in your retirement years. That means you can fund part of your retirement income through your home sale.
But what if you want to stay in your home? Then spending your excess money to pay down your mortgage leaves you with less cash on hand (also known as liquidity).
Bottom line: consider where your day-to-day retirement income will come from, and whether you can access it when you need it. That may mean selling or refinancing your home, if that's your main asset, or drawing from retirement accounts.
4. Could you earn more by investing than paying off your mortgage early?
This is probably the key question to consider. Let’s assume you’re applying an extra $19,000 to your mortgage. That's the average lump-sum payment made by Canadians allocating extra to their mortgage, according to Mortgage Professionals Canada 2019 State of the Mortgage Market report.
If you have a 5% mortgage on your home, this extra amount you’ve applied to your mortgage is equal to a 5% after-tax return on your money. That’s because you’re lowering the amount you owe the bank, on which you’re charged interest.
But could you do better than 5% by investing? It’s possible. The S&P/TSX Composite index was up an astonishing 19% in 2019. Of course, the stock market can be tumultuous and unexpected events (like a global pandemic) can lead to a temporary drop in your portfolio. Plus, you can’t predict future returns based on past performance. That means your decision will be driven at least partly by your comfort level with investment risk.
But remember, too, that investments in an RRSP can carry tax benefits. For instance, any investments you have growing in an RRSP are tax deferred. This means you won’t have to pay tax on those investments until you withdraw funds. This can make retirement investing a more attractive option.
Choosing between paying off your mortgage or investing for retirement
The answer to whether you’re better off funding your retirement account or paying down your mortgage is not clear-cut.
You may choose to compromise by using a blend of the two strategies – especially if you’re in the position where you have a long time to save for retirement and a long time to pay off your mortgage. That way, you can maximize both sides of the compounding interest equation.
- Find out which strategy is right for you. Try our RRSP v. Mortgage calculator.
Need help getting started? You may want to consider talking to an advisor. They can help you figure out a plan that suits your financial goals and needs. They can also answer questions or address any concerns you may have.
- Most advisors now offer to meet Clients virtually by video chat. Find an advisor today.
This article is meant to only provide general information. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.