Should Martin and his wife use TFSA to pay down a mortgage?

Article content

Q. Should I use my and my wife’s tax-free savings accounts (TFSAs) to pay off the $150,000 mortgage? It is my only current debt and between TFSAs and all our non-registered savings we could pay it off on renewal next year. We are both 50 years old and have worked on and off for 27 years. We earn about $100,000 between us annually and try to save $15,000 to $20,000 of that annually in TFSAs. We are fairly frugal and would like to retire at age 60 and would only expect to get two-thirds of Canada Pension Plan (CPP) each at that time. We have about $200,000 in total between us in registered retirement savings plans (RRSPs) and $15,000 in a savings account for emergencies if we use the rest of the money to pay down the mortgage. What are the pros and cons for us of doing this? Will we have enough to retire at age 60 if we keep on this savings path? Or, should we continue with mortgage payments as the rate is a fairly low at 3.5 per cent. —Martin

Article content

Article content

Article content

FP Answers: Whether to use your TFSA to pay off a mortgage is a complex question because your final decision will be based on several things: basic math, your current and future circumstances, and your general attitude toward debt, investing, and spending.

The math will be based on your best guesstimates of future investment, mortgage, and tax rates. Circumstances such as your ability to make mortgage payments, job security, future inheritances, and how you plan to use your home equity in retirement all come into play. Some key questions include: What are your feelings about debt? Are you a conservative or aggressive investor? What will you do after the debt is paid off? Will you remain frugal, spend or invest more, or work less?

I’ll work through some of the math and then look at the impact on your retirement. Also, because you have non-registered money we should discuss if it should go toward your mortgage, TFSA or RRSP.

Contributing to a TFSA or RRSP and paying down debt all have the same after-tax impact on your net worth if the interest rates remain the same on all three and for the RRSP you remain in the same tax bracket. Use that as a simple guide when deciding to add money to a TFSA or a mortgage, or deciding if you should use your TFSA to pay off your mortgage. Because interest rates are likely to be different and your tax bracket will likely change, put your money toward the one with the higher interest rate. This is when you can start guesstimating. You know your current mortgage rate but not future rates. Investments in equities are likely to have higher returns over time but there are no guarantees. In the end it is possible your general feelings toward debt will play a bigger factor than the math.

Article content

Article content

Your non-registered money will be invested more tax efficiently if added to your mortgage, TFSA, or RRSP. Again, contributions to a mortgage, TFSA, or a RRSP have the same after-tax impact assuming interest rates or tax rates stay the same. But in your case, they do not. There may be an advantage to investing non-registered money into an RRSP if you will be in a lower tax bracket when drawing out the funds, but I have a word of caution. When I, and other planners, say an RRSP and TFSA contribution provide the same future results, the assumption is that you will be making a pretax contribution to your RRSP and an after-tax contribution to your TFSA, which is something almost nobody does. For example, if you have $7,000 to invest in either your TFSA or RRSP, the TFSA is likely always the best choice.

To match a $7,000 contribution to your TFSA you must gross up your RRSP contribution to the amount you would have needed to earn to have $7,000 in your pocket. You can find this amount by dividing $7,000 by (1 minus your marginal tax rate, assuming 30 per cent). If you don’t have the additional $3,000 to invest, borrow it and pay it back when you get your $3,000 tax refund. If you are not grossing up your RRSP contribution, add your $7,000 non-registered money to your TFSA or mortgage.

Article content

To your other question about being on the right path to retire, the answer is yes, you are. You are doing all the right things, including living below your means, controlling debt and investing.

Based on the information you provided I estimate that after your mortgage payments, investments, CPP and employment insurance (EI) contributions, and tax, you have about $48,000 left annually to spend. If that is your retirement income goal, you should meet that at age 60.

When I model paying off your mortgage with TFSA money, keeping your spending the same and investing back into your TFSA, I don’t see a significant difference in your net worth at age 90 (assuming five per cent on TFSAs and 3.5 per cent mortgage rates).

However, if you pay off your mortgage and you don’t remain frugal and increase your spending by $18,000 a year (the estimated mortgage payment) you will not have enough money to retire without using the equity in your home, and even that may not be enough.

Article content

Keep in mind a mortgage or debt with a fixed payment schedule will take care of itself. Using your TFSA to pay it off won’t make too much difference to your net worth. It is what you do with your freed-up cash flow after the mortgage is paid off that will make a big difference.

Allan Norman, M.Sc., CFP, CIM, provides fee-only certified financial planning services and insurance products through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc., which is regulated by the Canadian Investment Regulatory Organization. He can be reached at alnorman@atlantisfinancial.ca.

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletters here.

Article content