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Mortgage or retirement savings? Where to get the most bang for your extra bucks

Jennifer Woodfine is constantly wondering whether she should use any extra money to pay down her mortgage faster, or put it towards retirement savings instead.
Canadian $100 bills are counted in Toronto, Feb. 2, 2016. Many Canadian homeowners struggle to decide on the best use of some extra cash: allocate extra money to pay down the mortgage faster or put it toward retirement instead. Maximizing your RRSP contributions is the best first step, one adviser says. THE CANADIAN PRESS/Graeme Roy

Jennifer Woodfine is constantly wondering whether she should use any extra money to pay down her mortgage faster, or put it towards retirement savings instead.

“The question I always ask myself is, if I am putting away $10,000 a year for retirement, but paying more than $10,000 a year in interest on my mortgage, am I better off to put that $10,000 against my mortgage to pay if off faster, and then when the mortgage is paid off, increase my retirement contributions exponentially?” Woodfine said.

The 35-year-old project manager, who lives in Hamilton with her husband and two daughters, has been contributing that extra cash flow to Registered Retirement Savings Plan (RRSPs). Her husband contributes $4,000 annually to an RRSP and she contributes $6,000 a year through employee shares in an RRSP. They both began this habit at a young age, with Woodfine starting at 15.

“We were always taught to contribute to RRSPs for retirement planning and the tax benefit. My employee shares are matched at 60 per cent so I consider that a non-negotiable,” she said. Woodfine is also putting some money in Registered Education Savings Plans (RESPs) for her kids’ educations. 

The question of whether to save for retirement or pay down mortgage debt is one of the most-asked questions by homeowners with some additional cash flow, said Ron Haik, a wealth advisor and client relationship manager at Nicola Wealth in Toronto.

For homeowners in a position to choose either to pay down a mortgage faster or further fund a retirement plan, Haik said the first goal should be to maximize your RRSP contributions with a goal of using the tax deduction toward your mortgage. 

By using your full RRSP contribution room, you’ll receive both the tax deduction for the contribution and tax-deferred growth on your investments, since those are not subject to taxes until you begin to withdraw. 

This strategy only works if you use the tax refund to pay down your non-deductible mortgage debt. Unlike in the United States, the interest paid on mortgage debt for primary residences is usually not tax-deductible in Canada.

If you have extra money after maximizing your RRSP and paying down your mortgage debt with your refund, Haik said you can split extra cash between paying down your mortgage further and maximizing your Tax-Free Savings Account (TFSA) contributions. 

Homeowners should see if their mortgage contract allows lump-sum payments or double-up payments, which go toward your principal repayment to help pay down the mortgage faster. 

“Most will allow you to pay up to 15 per cent or 20 per cent of the mortgage value in any year without a penalty,” he said.

Haik said there’s also another strategy called the Smith Manoeuvre that homeowners can use to help pay down the mortgage while saving for the future.

The Smith Maneuver allows you to convert non-deductible mortgage debt into deductible debt. You first pay down the mortgage, then borrow back the amount of principal that’s been repaid so that you can invest it. Your investments should be greater than the cost of borrowing to generate further income, which will be used to further pay down the mortgage debt, he said.

It's not for everybody. To do the Smith Maneuver, you should be comfortable with leverage, have a plan you can stick to when markets are volatile, and have some flexibility in your cash flow, Haik said. 

You’ll also need to be good at record keeping because you’ll need to separate the payments that you’re making to your mortgage from the payments that you’re making to the investment loan.

Further, you’ll need a Plan B in case you decide to move or the home value goes down, but typically, if you invest properly, he said, your portfolio should at least cover your loan, he added.

The advantage to the Smith Maneuver is that you're building up a large investment portfolio while paying your mortgage off, he said. 

You’ll be able to pay down your non-deductible mortgage quicker, depending on the return in your portfolio versus the cost of borrowing. 

The timeline can be significant. It could mean an eight-year reduction in mortgage payments compared to a standard amortization schedule and depending on rates of return and interest rates, he said.

Haik doesn’t recommend homeowners try the Smith Maneuver on their own, however. He strongly advises to only pursue this strategy with guidance and regular review from a financial advisor. 

This report by The Canadian Press was first published May 3, 2022.

Leah Golob, The Canadian Press