RRSP or paying down your mortgage: five questions to ask

A common question with an answer that depends on you

When a sum of money becomes available, two ideas almost always come up: put it into a registered retirement savings plan (RRSP) or use it to reduce the mortgage principal. Both moves are reasonable, and that is exactly what makes the choice hard: neither is the right one for everybody.

This article does not decide for you. It offers five questions to ask yourself, in order, so that you arrive at an authorized person with documents in hand and clear answers. Each question lights up a different angle: the room you have, the tax value of a contribution, your loan’s rules, your need to keep money accessible and the time ahead of you.

You will find no rate, no limit and no dollar amount here. Those figures change, and they are checked with the Canada Revenue Agency, Revenu Québec and your lender. CompareTaux shows no rates and makes no decision: the service routes a request to an authorized person, registered with the Autorité des marchés financiers (AMF), who can apply the rules to your situation.

1. What is my unused room?

Before anything else, you need to know how much contribution room you have. It is not the same for everyone: it depends on your past earnings, your earlier contributions and several other elements. It is shown on your notice of assessment from the Canada Revenue Agency, which you can find in your online account.

Why start there? Because contributing beyond the allowed room can lead to penalties. Many people pay in a sum relying on a memory or an estimate, then discover the gap later. A check that takes a few minutes avoids that kind of surprise.

This question also affects the comparison itself. If the unused room is thin, the RRSP option is limited, and the discussion naturally moves to other uses of the money. If it is substantial, the question is more open.

Keep in mind:

• contribution room is read in your official documents, not in an advertisement;
• it carries forward from year to year when it is not used;
• it cannot be guessed: check before you contribute.

An authorized person can help you interpret the notice of assessment if some elements look unclear.

2. What is my marginal tax rate?

An RRSP contribution lets you reduce your taxable income for a year. The value of that deduction depends on your marginal tax rate, meaning the tax you pay on the last slice of your income. The higher that rate, the more the deduction weighs in the comparison. At a more modest income it weighs less, and the comparison may tilt elsewhere.

Mortgage prepayment, for its part, gives no deduction. It reduces the principal owed, and therefore the interest to be paid later, but it does not appear on your tax return. The comparison therefore involves two effects of a different nature, one fiscal and immediate, the other financial and spread over time.

You also have to think about the future. An RRSP is generally taxed when money is withdrawn: the question is not only how much you save this year, but what your tax situation will be when you take the money out. That projection is difficult to make alone.

Revenu Québec and the Canada Revenue Agency publish the official tables. An authorized person or a tax specialist can work through scenarios with your real data.

3. What does my mortgage contract say?

Paying more on your mortgage is not always as simple as it looks. Contracts provide prepayment privileges, and these vary a great deal from one lender and product to another. Some contracts cap extra payments each year, others allow them only on certain dates or as higher regular payments.

If you go beyond what is allowed, charges may apply. It is therefore wise to reread the section of the contract that covers these privileges, or to ask the lender directly, before making your decision. Write down the answer.

Other elements of the contract matter:

• the end date of the term, at which renewal often offers more flexibility;
• the type of rate (fixed or variable), which changes how a prepayment translates into savings;
• special conditions, for instance in the case of an insured loan.

What the contract says sets limits on the mortgage option before you even compare it with the RRSP. It is a concrete starting point that depends on no assumption and can be checked in a single conversation.

4. Do I need liquidity?

Liquidity is how easily you can get a sum of money back. It is often underestimated in this comparison, yet it matters as much as the tax considerations.

Money paid on the mortgage is hard to recover. To get it back, you generally have to borrow again, which involves a process, possible fees and a new approval. Money in a savings account, on the other hand, stays accessible. An RRSP sits in between: the money is available, but a withdrawal is generally added to your income and taxed, and the contribution room used is not recovered outside particular programs.

Think about your emergency fund. If a loss of income, a repair or a family surprise occurred, how much could you reach quickly without going into debt? If the answer is little, locking up more money, in either direction, deserves some thought.

A good way to put the question: if I needed this sum in six months, where would it be, and at what cost could I get it back? The answers differ a lot from one option to the other.

5. What is my horizon?

Time works in both directions. A distant retirement gives more time to money placed in an RRSP, with the risks and uncertainties that entails, since the value of an investment can fall as well as rise. An approaching end of mortgage term, on the contrary, can make prepayment more attractive or more flexible, because privileges are renegotiated at renewal.

Other projects enter the horizon: a renovation, a major purchase, a job change, a birth, a retirement sooner than planned. Each one can move the balance point.

To clarify your horizon, ask yourself three questions:

• when is this money likely to be needed?
• when does my mortgage term end?
• when do I plan to stop working or reduce my income?

There is no right answer in itself. What matters is that they are written down before you speak with an authorized person. Without a defined horizon, a numerical comparison stays abstract and may lead you to a choice that does not fit your real life.

A hypothetical scenario

Imagine Karim and Léa, a couple who receive an unexpected sum at the end of the year. They hesitate: one would like to reduce the mortgage, the other to contribute to an RRSP. They have not yet opened their notices of assessment.

Before arguing about the answer, they decide to work through the five questions. They find that unused room remains for one of them, but almost none for the other. They reread their contract and see that extra payments are allowed up to a yearly limit. They also realize that their emergency fund is thin, which leads them to keep part of the money accessible.

They book an appointment with a person registered with the AMF, bringing their notices of assessment, their contract and a simple budget. The discussion covers the split, the right year to claim the deduction and the renewal calendar.

This scenario is fictional, has no figures and guarantees no result. It shows an approach: gather the documents, answer the five questions, keep a share of liquidity, then decide with someone who knows the file. The final decision belongs to them.

Mistakes to avoid

Several mistakes recur in this decision, often from missing information rather than poor judgment.

• Contributing without knowing your contribution room, and risking going over the allowed limit.
• Exceeding the contract’s prepayment privileges and being charged fees.
• Putting all your liquid money into the mortgage and having no cushion for a surprise.
• Borrowing to contribute without looking at the total cost of that loan and how it will be repaid.
• Relying on a general rule heard elsewhere (always one, always the other) instead of your own numbers.
• Forgetting that RRSP withdrawals are generally taxable and do not restore the room used.
• Ignoring your spouse’s or partner’s situation, when some couple strategies can affect family taxes.
• Deciding under pressure from a deadline, without taking time to compare.

None of these mistakes is irreversible, but several cost time or money. An authorized person can spot them quickly if you show your documents. It is better to consult before paying in than after.

Questions to ask an authorized person

Here is a list to bring to your appointment. Ask for the answers in writing, and check that the person is registered with the AMF.

• What is my exact contribution room, and where do I read it in my official documents?
• In my situation, would the deduction weigh more this year or later?
• Which prepayment privileges does my contract allow me to use, and under what conditions?
• How much should I keep accessible before locking up the rest?
• What is the concrete difference between these two options over my horizon?
• What fees or penalties apply to each option?
• How are you paid for what you are proposing to me?
• Is there a split between the two that suits my budget?

A vague answer is itself information. If you are pressed to decide immediately, remember that there is nothing final about taking a little time.

Keep a copy of the documents exchanged: they will serve your tax return and any later review. For a first step, CompareTaux can route your request to an authorized person, with no rate displayed and no automatic decision.

Frequently asked questions

Sources

• Canada Revenue Agency
• Revenu Québec
• Financial Consumer Agency of Canada
• Autorité des marchés financiers