RRSP or Mortgage: What To Do With Your Tax Refund?

The debate that always comes up around this time of year is whether to use your tax refund to top up your RRSP or to pay down your mortgage.

Depending on your situation and your risk tolerance you could go either way.  As a general rule, unless your RRSP returns are consistently higher than the interest rate on your mortgage, you are likely better off paying down your mortgage.

Related: Should You Pay Off Your Mortgage Early Or Invest?

There are a few different factors that you may want to consider before making this decision.

Use Tax Refund To Pay Down Mortgage

If you have mortgage debt, you probably can’t go wrong by using your tax refund to make a lump sum payment on your mortgage.

It’s a guaranteed return on your money and will help reduce the overall amortization of your mortgage.  If any of the following categories apply to you than you may want to consider paying down your mortgage instead of investing:

• You have a long amortization period remaining – Canadians who were able to take out 30, 35 and even 40 year mortgages just to get themselves into the housing market over the past few years should absolutely consider making lump sum payments in order to reduce the number of years left to pay on their mortgage.  Making just one extra mortgage payment per year can shave 5 years off of the life of your mortgage.  You don’t want to retire with housing debt.
• You have a high outstanding mortgage balance – If you have a high mortgage balance on a regular amortization schedule (25 years or less), you still want to consider using your tax refund to help pay down your balance.  Again, making just one extra mortgage payment per year can save you $10,000 in interest charges over a 5 year term.
• You are in a low tax bracket – If you are in the lowest tax bracket the tax refund from your RRSP contributions are a lot smaller.  In Ontario, if you contribute $2,000 to your RRSP at the lowest tax rate you would get a $444.00 refund.  However if you were in the highest tax bracket you would get a $928.20 refund for the same contribution.

Use Tax Refund To Top Up RRSP

In some situations it makes to use your tax refund to top up your RRSP.  Investing in a tax sheltered account means years of tax free compounding within your RRSP.  Your rate of return from investing will likely beat the low interest mortgage rates today (although nothing is guaranteed).  Here are a few other examples:

• You took out an RRSP loan – While this is not technically investing your tax refund in an RRSP, if you took out an RRSP loan it is imperative that you use your tax refund to pay off the loan.  Most RRSP loans give you a 90 day grace period between the loan date and when the interest payments kick in.
• You are have unused RRSP contribution room – Why not take advantage of all of your contribution room and max out your RRSP?  Every dollar you invest in your 30’s should be worth at least $5 in your 60’s.  Get your money working for you early.
• You are in a high tax bracket – If you fall into the highest tax bracket you can’t beat the return from making RRSP contributions.  As noted in the example above, a $2,000 investment would get you an additional $928.20 tax refund.

Don’t Forget Your TFSA

When the Tax Free Savings Account was introduced in 2009, Canadians were given another option to help confuse us even more.  The TFSA has plenty of advantages, including:

• Everyone 18 and older can contribute up to $5,000/year, regardless of their income.
• Investment gains can be withdrawn tax free.
• Any amount you withdraw, you can re-contribute the following year (or any time after that).

What’s The Best Option?

It’s hard not to feel overwhelmed by all of the different financial options available to us.  Most Canadians can’t afford to make additional mortgage payments while maxing out their RRSP and TFSA at the same time.

When faced with the choice of what to do with your tax refund, you can’t really go wrong with any of these options.

Related: Our Fast Track To Financial Freedom

Rather than sprinkling a few dollars here and there, concentrate on making the biggest impact in one particular area.  If it’s important to be debt free, then put your extra money towards your mortgage.

If it’s a comfortable retirement that you’re after, focus on your RRSP contributions. And if you are saving for a shorter term goal like a down payment on a house, try maxing out your TFSA every year.

And if you feel comfortable with your current and future financial situation, just take your tax refund and book a trip to Vegas 🙂