Assuming you have withdrawn $25,000 from your RRSP (first time home buyer's plan) is it better to:
A) Repay the RRSP withdrawal within 15 years so you don't get taxed
or
B) Forget about RRSP repayments for the time being and focus on making lump sum payments on the mortgage principal every year (as much as you can afford)
Thoughts?
Not making the repayments means that the minimum repayment amount is added to your income each year. Essentially each year the issue will be do I put $1667 dollars into my RSP to meet the minimum payment or do I put that against my mortgage?
Putting the $1667 into your RSP means you don't have to pay the tax on the amount and putting it against your mortgage means you save interest going forward.
At a moderate 40% tax bracket [though as a 'dr' of love you would be in a higher tax bracket presumably] the repayment of $1667 saves you $667 of tax that you would have to pay if you instead put the payment against your mortgage. Additionally, you would gain the growth on that extra $1667 into your RSP and with a moderate 7% return you might expect $117 average growth per year [but compounding as well].
The $1667 against your mortgage would save you interest and if you took a long term average mortgage interest rate of 5% that means you would save $83 of interest every year.
So, bottom line for this 'average' scenario, RSP repayment saves $667 upfront and average growth of $117 per year vs. mortgage repayment saving you $83 per year.
In twenty years, RSP would be $6450 higher from one time repayment. On the other hand, over the same twenty years you would save $2750 in interest expense by putting that one payment against your mortgage.
The numbers will vary depending upon your actual tax bracket and your actual returns and interest rates experienced. As well, it bears mentioning that the interest savings are after tax dollars while the RSP gains will eventually be taxed when your RSP is collapsed but for most people the extra RSP amount will be exhausted and taxed many decades down the road so the taxable status is not that material.
Your assumptions will affect the analysis but for most people the large tax savings upfront and tax free growth over the long term make the RSP an attractive option compared to paying down low cost debt but you need to examine your individual situation closely and consider your personal comfort level in carrying the debt. Higher tax bracket or higher expected investment growth rate or lower expected interest rates all would tilt the scales towards the RSP repayment.
Hope that helps.
D.
