Should I make an RRSP contribution or concentrate on mortgage repayment?

We all want to be out of debt as soon as possible, yet that nagging feeling continues that retirement is coming sooner rather than latter. It's very difficult to make a general statement about whether it's better to pay down your mortgage or make contributions to an RRSP. What information do you need to make the decision that is best for you?

Let's compare apples to apples -- or, in financial terms, deductible deposits versus non-deductible debt.

Let's say you have a mortgage (for most homeowners, a non-deductible debt) on which you are charged 10% interest. If your income is $40,000 per year, you are in a 40% marginal tax bracket.

Before paying each dollar of interest on debt owed to your bank, trust company, or credit union, you must first earn $1.67. You pay 67 cents to Revenue Canada and end up with $1.00 to service your debt load. Put another way, this debt costs you not 10% interest but actually 10% + 40% tax, for a total of 17%! Where else can you earn 17% on a guaranteed investment?

On the other hand, for every dollar "socked away" in your RRSP account, all tax is refunded by revenue Canada. You still have the dollar plus the money which would have gone to tax (as well as the interest the RRSP earns).

By paying off your debt now, you will increase your ability to put more in your RRSP after your debt payments are gone. By making RRSP payments now, less will need to be saved later because compound interest will be working for you longer. One thing is a given: excess cash should be tax-sheltered whenever possible, for as long as possible.

Perhaps the best approach is to do both. Make RRSP contributions as early as possible each year. Then, in May or June, use your tax refund to reduce your debt. That way you have the best of both worlds: your debt is reduced and you are building a sizeable nest egg for retirement.

Make informed decisions to do something now to improve your net worth. Pay down your mortgage as quickly as possible, make maximum RRSP contributions, or take the middle of the road approach and do a little of both.

As a first step, see our free RRSP fact and strategy guide outlining new deposit limits and potential strategies we should all consider to maximize the return both of our dollar and on our dollar.