RRSP vs. MORTGAGE PAYDOWN

Some people feel that it is more important to pay down the mortgage rather than contribute into RRSPs. While reducing your mortgage quickly makes sense, you should recognize that you'll need a significant nest egg to retire comfortably.

There is a way to accomplish both goals, however. Contribute to your RRSP and use your tax refund to pay down your mortgage. You'll be building your nest egg and reducing your mortgage at the same time!

Here's an example that asks the question:

Is it better to pay down the mortgage or contribute to an RRSP?

Certainly every situation is different and mortgage rates change over the years, but let's consider this example: Assume a 42% marginal tax bracket and a maximum RRSP contribution room of $12,000. Tax savings from the contribution are approximately $5,040 in this case. This equates to $420 a month of new money that can be applied to the mortgage.

Now let's assume the $125,000 mortgage is amortized over 25 years and an average interest rate in that period of 6%. Monthly payments are $799.76. If this is bumped up by the $420 a month in tax savings from the RRSP, the taxpayer cuts the amortization period by 13 years. The results are the following:

Accumulated tax-sheltered earnings on growth of annual $12,000 contributions for 12 years, compounding at a before-tax rate of return of 6% amounts to about $214,600.

Interest savings on the reduced amortization period of 12 years rather than 25 years equals approximately $65,300.

Total accumulated principal and earnings in the period will produce net worth of $214,600 in the RRSP and $125,000 in home equity and a further $65,300 in interest savings for a total of $404,900 all from an investment of just $144,000 ($12,000 x 12 years).