RRSP Contributions vs. Extra Mortgage Payments

I don't want to come off as critical of the RRSP. In my previous post I wrote that I feel that this is one of the only things that gets a lot of Canadians saving and it is one of the only legitimate tax savings vehicles for salaried employees. However, when asked what is good money management and the secrets to building wealth I will always tell people the same thing:

Do what you can to save as much tax as possible and do what you can to reduce the amount of money you are paying to institutions.

This all comes back to cash flow. Keep more of what you earn in your pocket. What you do with it at that point is a whole different story. My personal belief is that the average Canadian today is stretched to the limit with cash flow and doesn't have a lot left at the end of the day for savings or RRSP contributions. This can be attributed to things like high mortgages, compounding debts, and costs related to everyday life.

I was recently reading an article talking about pre-tax dollars and where is the best place to put them: RRSPs, non registered investments, or extra contributions towards a mortgage. This takes into account that an investment in a non-registered investment or an extra contribution to a mortgage would be done with after tax dollars. When that is taken into account the RRSP argument is going to win every time. Not only on the benefits of the contribution itself, but also on the tax end, even though the RRSP is the worst form of taxation you will have. This study was done on the basis that some investors feel that the loss of the dividend tax credit and/or capital gains/losses can be an upside to investing outside of an RRSP. The numbers prove it and once again the RRSP comes out on top.

You can have a look at the article here.

However, something I stumbled upon years ago was The Smith Maneuvre. I have been interested in the ins and outs of the Smith Maneuvre since 2003. What Fraser Smith preaches is the benefits of the tax deductible mortgage. He is right that there are many benefits to changing your payments to generate more tax savings. However, the by product of what Smith promotes is a reduction in the ammortization period of the mortgage itself. In my opinion that is a more attractive result to the average Canadian than just the tax savings. What Smith has done is incorporated the use of 'good debt' to fuel this strategy.

Smith was not the first to use this strategy. However he was the first to market it well. He did it so well that he actually tied his name to it. Talbot Stevens actually wrote about the same strategy in the book 'Dispelling the Myths of Borrowing to Invest' Stevens is a promoter of the use of conservative leverage on many fronts and he does it well. In fact, many of the strategies that I employ come from Stevens in one way or another.

The point that I am trying to make by referring to these two pioneers of the use of leveraged investing is that they are restructuring the use of this tool to use the tax benefits to apply to mortgages. The reason is is that for every dollar that is spent on interest used towards an eligible investment is 100% tax deductible. Each dollar is treated the exact same way as any dollar that is put into an RRSP.

The benefit here, in relation to my previous points, is that when these tax deductions are applied to a non-registered asset that is subject to dividends and/or capital gains the non-registered investment will come out on top every time in terms of money in your pocket. That is because the money being used is no longer after tax dollars like in the article I noted above. Not only that, but when you use leveraged investing you will usually have a larger sum of money working for you sooner, thus taking advantage of time. The end result is the same tax savings with a larger investment subject to less tax.

Back to the RRSP contributions vs. extra mortgage payments. My argument is if you can use tax deductible dollars to apply a leverage strategy towards a tax efficient income stream (which is a whole other entry) and apply that towards extra contributions on your mortgage you will be ahead for many reasons. I will list a few.

1) Every person who has accelerated their mortgage in one form or another knows the thousands that can be saved in non-tax deductible interest going to institutions

2) The freedom of being mortgage free sooner can provide for more time to take advantage of compounding. Not only that but you will have more cash flow to contribute to a plan through dollar cost averaging.

3) The continuation of leverage use on a conservative, educated, and long term method can not only provide for a compounding tax savings over the years but also a dramatic increase in wealth.

4) No mortgage, a house, and a tax efficient investment portfolio beats no mortgage and a house.

Again, I am not saying that RRSPs are not a valuable tool for the average Canadian. I am just saying this is my recommended solution to a common question. These are areas that need to be explored when talking to average Canadians today.