Build your home equity and your RSP

A couple reviews their finances on their computer.

You can contribute to your RSP and pay down your mortgage.

For homeowners who are also actively saving for retirement, the perennial question often is: Should I maximize my registered Retirement Savings Plan (RSP) contribution or increase the equity I have in my home with a mortgage prepayment?

There really is no right or wrong answer. Both options will help you build your net worth over time. The decision that’s better for you will depend on a number of factors, including your current situation, your marginal tax rate, your long-term financial plans and the economic outlook.

If you can invest more in your RSP, you’ll have greater potential to take advantage of tax-free compound growth and build your nest egg. Today there are opportunities to buy equities at more attractive valuations. Conversely, if you can pay down your mortgage more quickly, you build home equity, reduce interest costs and become one step closer to living debt-free. So which choice is right for you?

The case for your RSP

Even if intuition suggests that it’s “safer” to put your money towards an asset like your home, which has a tangible value, it would be a mistake to equate your house to a future retirement fund.

It is risky to tie up most of your savings in a single asset — real estate — without diversifying into other financial assets as well. Diversification should apply to your total wealth. In addition, equities have traditionally provided excellent returns over the long term. While the economic downturn of the past year or so depressed values considerably, the fact is, historically, equity markets have recovered from such downturns and gone on to new highs.

Of course, contributing to your RSP also gives you one of the best tax breaks available.

The case for your mortgage

There are two situations in particular, however, when paying down your mortgage may be a priority:

As you approach retirement. Many pre-retirees focus on paying down their mortgage so that they can retire debt-free and not have to worry about regular mortgage payments when they are no longer receiving regular employment income.

If you have a Registered Pension Plan (RPP). If you belong to an employer-sponsored pension plan, your RSP will be restricted to reflect your pension accumulations.

While you can augment your retirement savings by contributing to a Tax-Free Savings Account (TFSA), annual TFSA contributions are limited to just $5,000 a year¹. Using excess cash to pay down your mortgage will reduce your interest costs and increase your equity without any ongoing taxation, unlike investing in non-registered assets.

You can do both

The easiest solution to the classic dilemma between contributing to your RSP and paying down your mortgage is to do both. Make your maximum RSP contribution to lower your taxes this year, and then apply your tax savings to your mortgage.

Depending on where you live and your income tax bracket, your RSP contributions could return as much as 45% in tax savings. You can use this money to chip away at your mortgage debt, build home equity and still not miss out on investment opportunities within your RSP.

Financial planning can help you determine which savings decision will serve you best years from now, when it matters. Keep in mind that any calculations used to compare the relative advantages of RSP savings and home equity will always be based on assumptions about rates of return and home values, which can vary widely.

If you’d like to discuss the best strategy for your situation, a Business Development Associate at one of our TD Waterhouse Investment Centres can help. Find a Business Development Associate in your area.