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The Mortgage Or The RRSP?

It's not hard to figure out where Canadians are spending their investment money these days. Real estate sales have hit record levels for several years in a row. The vacation property market is hot. Renovation contractors and building material retailers have never been busier.

With interest rates not expected to rise for some time, Canadians will keep pouring money into their homes for at least the next couple of years. Manulife Financial, which maintains the quarterly Investor Sentiment index, says that investing in their own homes, either through renovations or paying down the mortgage, is the most popular place for Canadians to put their money. In the most recent survey, 65 per cent of respondents said it's a good or a very good time to invest in their own residences, which was up five points from the September survey.

Real estate other than their own homes was the second most popular investment, up three points from September.

Manulife says the leading non-real estate investment vehicle is the Registered Retirement Savings Plan (RRSP). The RRSP index suffered a drop in September, but it bounced back in December. In the most recent survey, 63 per cent of respondents said it was a good or very good time to put money into RRSPs.

RRSPs are popular among Canadians as a retirement "nest egg," because they offer tax breaks as they increase in value. Many Canadians have also taken advantage of the federal government's Home Buyer's Plan, which allows buyers to withdraw up to $20,000 from their RRSP to help pay for a home. The money is tax-free as long as it is repaid within 15 years. More than a million people have taken advantage of this feature since the plan was introduced in 1992.

This is the time of year when companies that sell RRSPs are bombarding consumers with reminders that time is running out to "top up" their RRSP contributions for the 2004 tax year. Homeowners with a little extra money are faced with the question of whether it's better to contribute to their RRSP, thus adding to their savings and reducing their tax load, or paying down their mortgage, which is never a bad thing because it increases the equity in your home.

Some financial planners say it's best to contribute to an RRSP and use your tax refund to pay down the mortgage. Mortgage interest rates, while not as good as last year, are still very low by historic standards so you may be able to get a better return within your RRSP than what you'll save on mortgage interest payments.

Others say that depending on the size of the mortgage and your age, you may be better off to put all the money toward the mortgage to reduce the amount you pay in the long term. Toronto real estate lawyer Bob Aaron took a look at almost 200 Canadian websites to get opinions on the matter, and he concluded that many of the sites had misleading or incorrect information. Most are sponsored by companies that earn commissions on RRSP contributions, while no one earns a fee when a homeowner pays down his mortgage.

The best advice is to take a close look at your own financial situation, taking into account the mortgage interest rates versus the expected return of the RRSP; your age and the length of time in the mortgage or RRSP; the availability of RRSP contribution room; your income; whether you are self-employed and/or have a company pension plan; and whether you can capitalize on mortgage prepayment privileges.

Generally speaking, if it's a long-term investment, you may be better off going with the RRSP. But if you are in a low-income tax bracket and are struggling to meet mortgage payments, it makes more sense to put as much as you can toward the mortgage and leave the RRSP contributions for later. Get some unbiased financial advice.

Another recent survey, by The Investors Group suggests that there's a sharp contrast between what baby boomers are planning for their retirement years, and the lifestyles of current retirees.

For example, Investors Group says 28 per cent of baby boomers say they plan to purchase a vacation property, motor home or boat in their retirement, but only 15 per cent of retired Canadians have actually done so, or plan such a purchase.

Investors Group says the boomers will "redefine" retirement and be more active than current retirees. But the poll also found that 56 per cent of baby boomers had not figured out how much income they will need during retirement, or how much they needed to save or invest to reach this target.

The company suggests that as you approach retirement, you should take the time to define your goals for retirement -- such as whether you want to travel or buy a vacation property. Work with a professional financial planner to determine how much after-tax income your savings and pension plans will generate, and then develop a strategy to achieve your retirement goals with specific savings and investment plans. Finally, monitor the strategy annually and make adjustments for any changes in your goals or personal situation.

Canadians' Investment Dilemma: The Mortgage Or The RRSP?
[Realty Times]

January 14, 2005 in Money Matters | Permalink