RRSP Season

We are just into February and I am sure you are being bombarded with advertising about RRSPs. I received my Money Sense magazine earlier in the week and I wanted to share a portion of the article about RRSPs.

Q. I have a pension. Do I need an RRSP too?

A. For most people the answer is yes – although if you have a good pension at work you can certainly contribute less to your RRSP than someone without one. With no pension, you can contribute up to 18% of your income to an RRSP each year. If you have a private pension, then the amount you are allowed to contribute to your RRSP will be reduced, to reflect the fact that you are also contributing to your retirement income through your pension at work.

There is one group that doesn’t need RRSPs at all: government workers. Teachers, police officers and other civil servants have among the best pension plans available and won’t need help from RRSPs to retire comfortably. For instance a couple who are both government workers can expect to enjoy a combined annual pension income of at least $50,000 with is roughly the kind of income that a million dollar portfolio would generate

Q Which should I contribute to first: my mortgage or my RRSP?

A. Financial planners have debated it for years, but from a pure dollars-and-cents perspective the correct answer is usually to pay your mortgage down first. Every time you make an extra mortgage payment you reduce the amount owed on the principal. If you mortgage interest rate is 5%, paying it off faster is like getting a guaranteed 5% return. yes, you can get a better return than that in the stock market (if you’re lucky), but it’s no guaranteed. So unless you can find GICs that pay 5% you may want to attack the mortgage first.

I want to add a couple of comments to these points. If you are carrying a balance on any high interest debts such as credit cards or loans you are better off paying them before your RRSP and mortgage. Those who are involved in a group RRSP plan where your employer matches your contributions should contribute to these plans before making additional mortgage payments.

What do you plan to do this year, pay down your mortgage or contribute to your RRSP?

Create Your Own Mortgage Down Payment

A couple of months ago I wrote about No Down Payment Mortgages and evaluated if they were worth the money. First time home buyers as defined by the CCRA can use an RRSP and the Home Buyer’s Plan to get a better deal if they do not currently have any money for a down payment or any RRSPs.

In the next couple of months realtors, mortgage brokers and some financial institutions will market this strategy.

I am going to used the same numbers as used when I evaluated the No Down Payment Mortgages. You want to purchase a $300,000 home but you have no down payment or no RRSPs. You go to your bank and request a loan for $15,000 to purchase an RRSP. The bank will be happy to give you this loan somewhere between Prime & Prime +1 because you will then put it in an RRSP set up at their branch. You will need the money shortly so just place it in a savings account within the RRSP. CCRA requires the money to be in the RRSP for 90 days before you can take it out and use it as a down payment. Use this time to begin looking at homes and working with your bank or mortgage broker to ensure that you will qualify for your $300,000 home. You find your home and withdraw the $15,000 from your RRSP under the Home Buyers Plan. A month later you move into your new home.

Your new mortgage is $285,000 plus $7,838 for CHMC premiums for a total of $292,838. Your payments over 25 years are $1,602.92 a month. You still have the original RRSP loan to pay off so over 5 years you have monthly payments of $276.02. I have used 4% as an average interest rate for the RRSP loan. The total payments over five years with the No Down Payment example would be $111,015.64 and the total of the mortgage payments and RRSP loan payments over 5 years in the RRSP example would be $112736.52. Your total payments for 5 years with the RRSP as a down payment are an extra $1,720.88. Not a good thing, but now we have to look at your mortgage balance to have a fair comparison.

The mortgage balance with the No Down Payment example after 5 years would be $262,898 compared to the balance of RRSP as a down payment example of $256,630. There is a difference of $6,268. Take into account the $1,720.88 over the five years with the No Down Payment Mortgage and the RRSP as a down payment wins by $4,546.67. Not a bad savings.

There are various other things to consider that I have not addressed and it is suggested that you get professional advice before you attempt this to purchase your home. You will get a tax refund for the initial RRSP deposit, but you will either have to pay that money back to your RRSP over the next 17 years or get taxed on $1000 each year.

I did not factor the refund or the yearly payback amounts into the scenario because people are in different tax brackets and have financial situations. The tax refund arriving around the time you purchase a new home will be nice though. Talk to an expert, your realtor, mortgage broker or bank rep should be able to help you out.

I wanted to see exactly how this was marketed and found a clip this clip from an Investors Group Planner.

Although it is an interesting twist on an RRSP loan and the Home Buyer’s Plan which may be effective for some people he neglects to mention that you will have to pay back the money you took from your RRSPs to pay off the loan or be taxed on it. You have a two year grace period and then you have to make monthly payments of $222.22 over the next 15 years.

He also suggests not rushing to pay off your mortgage. Although there are many variables to consider, you will not find any guaranteed investment that will beat making extra payment on your mortgage and paying it off sooner.

This is an excellent article from the Globe and Mail that highlites paying off your mortgage rather than investing.

There are many things to consider with this strategy. Do you qualify taking the RRSP loan into account? Do you have money available for closing costs? Is your credit adequate to qualify for a mortgage? Do you have $15,000 of contribution room available in your RRSP? Can you use this strategy to add to savings and come up with a 20% down payment,saving yourself a few thousand dollars of CMHC premiums?

Talk to an expert, your realtor, mortgage broker or bank rep should be able to help you out.