RRSP, RESP, TSFA or Mortgage prepayment? Which has the best returns?
HOW TO GET THE MOST OUT OF YOUR MONEY
Trying to decide what’s the best move can be difficult…. and I must admit, this is not an easy subject to tackle. There are so many opinions…. But it’s important enough that I’m going to put my 2 cents in. My final recommendations are listed at the bottom if you want to fast forward…
First, let’s come to an understanding that we are all different and have different needs…. you must ask for professional opinions and make up your own mind. Having said that, I think that for me, this is actually a very easy decision.
RESP If you have kids, put money into an Registered Education Savings Plan… the govt gives you 20% on a max contribution of $2500/yr per child.. that’s $500 of free money… Just be careful to not invest in any risky funds or stocks… you’re making 20% return already… don’t get greedy.
TFSA If you have some extra cash, then yes, put those funds into a Tax Free Savings Account. You can contribute $5,000 per year and any unused contribution limit carries forward each year… and the good news is that whatever investments are allowed for RRSPs are also allowed for TFSA. Funds can go in and come out and grow tax free. But I wouldn’t be putting too much in here while you still have a mortgage… Pay your mortgage off first.
RRSP An old favorite for many. Millions of Canadians have contributed to RRSPs in an attempt to be masters of their future and retirement. Mutual Funds have become a favorite investment within RRSPs. But now let me ask you… how has your RRSP performed for you? For most of us, that answer comes with some profanities…%@!)*&%!!! or something like that.
RRSP contributions are tax-deductible… and higher income earners will benefit greater…your funds can grow, tax-free… but you must pay taxes when you withdraw the funds. At age 71, you have 3 options…-transfer to a Registered Retirement Income Fund, -buy a life annuity (better when interest rates are high), -or take the cash (bad choice as you will have to include those funds as income in one tax year which will result in large tax bill.)
RRSPs are a way to grow your investments, tax-free, and defer paying the tax… but you will have to pay the tax… make no mistake about that…
MORTGAGE PREPAYMENT Probably the least exciting but the best choice for many.. just pay down your mortgage… your mortgage is not tax-deductible, unless you have a mortgage on an investment or rental property. Get rid of that mortgage faster..make prepayments… even little prepayments done regularly will make a difference…. On a $300,000 mortgage, a $3,000 annual prepayment will shorten your amortization from 25 years to 20 years, 10 months. Based on today’s 3.29% mortgage rate, that’s a savings of over $28,000. Hey, a $28k return on a $45k investment isn’t bad.
ONE MORE OPTION…INVEST IN REAL ESTATE Sure, we’ve all seen property values go up over the last few years… actually, they’ve gone up over the last 12 years.. this is a long bull market for real estate… and there will probably be a correction. But if you buy a rental property, you should plan to hold it for the long-term… 7 years or more… that’s usually enough time for any price correction to reverse itself. Rental properties are popular today because mortgage rates are low and vacancy rates are even lower.
Another way to invest in real estate is through private mortgages. Private mortgage rates run from 10% to 15%. It takes a little more knowledge and experience to understand this investment, but it could be worthwhile.. Just be careful to get as much information as possible before making any 2nd mortgage investment decision. These are RRSP eligible too. This subject will have to be covered in greater detail as there is a lot more to it.
FINAL DECISIONS. For me, RRSPs just haven’t performed well… And maybe I haven’t invested wisely…. One thing is certain, my Investment Advisors and Fund Managers all won… they take their cut off the top… Not all Investment Advisors are alike, but I seemed to have hooked up with those that talked a better game than they could deliver. Here’s a question… were you ever put into a Deferred Sales Charge (DSC) mutual fund? You know, the funds where you can’t exit the fund family for 5 or 6 years without paying a hefty penalty? I know several friends and clients that got pushed into those funds…. not one of them is happy… I am staying away from these funds…
In case you can’t tell, I’ve lost my faith in mutual funds and decided to manage my own money.. and guess what? I’ve done better than any advisor I know… I’m sure there are good advisors out there…but I’ve just decided that no one will care more about my money and future than me…
It’s time to take charge of our money…. so here are my suggestions…
- Put money into an RESP… if you have kids, this is a no brainer… make sure to park that money in a safe, low risk investment… remember, you already made 20% with the govt’s contribution….let’s not get greedy.
- Pay off your mortgage. Make lump sum prepayments… anything.. something is better than nothing… and try to increase your regular payments… this will accelerate the retirement of your mortgage.
- If you have to invest in stocks or funds then put this into a TFSA…
- Invest in real estate… it’s not exciting.. it’s not sexy… but history tells us it goes up over the long run…
- RRSPs… putting them last on my list… I’m just not a fan of them… if you have other cash, why not invest it elsewhere… but if you have to put money in RRSPs, play it safe.. this is your future, your retirement… don’t gamble with it.
- Seek professional advice…. if you’re not sure what to do, get some advice… if you don’t have anyone to turn to, feel free to contact me… if I can’t answer your questions, I’ll direct you to someone who can.
Steve Garganis View All
As an industry insider, Steve will share info that the BANKS don't want you to know. Steve has appeared on TV's Global Morning News, CBC's "Our Toronto" and The Real Life TV show. He's also been quoted in several newspapers such as the Globe and Mail, The Toronto Star, The Vancouver Sun, The Star Phoenix, etc.
Great advise, but I do believe you missed a point. At the end of the day it’s all about percentages, similar to credit card debt, one should try to get the biggest percentage return on their investments (which is what we are basically talking about here).
Here’s an example where RRSP makes the most sense:
Imagine an individual with income of >100K/yr, and a lot of RRSP contribution room. Imagine this person has 10K of disposable income to contribute this year. With a variable mortgage (lets imagine 3%), as long as RRSP funds generate more than 3% per year, the person is A LOT further ahead than paying down the mortgage. Most GIC’s and similar investments today will return close to that amount.
In addition, you forgot to count the tax return on that 10K. It could be as high as an additional 4K (that’s 40% growth in a single year!) You can then take that 4K and put it back into RRSPs (and get 1.5K return next year, and so on and so on and so on). Or, take the 4K and pay down the mortgage.
Net result: 10K in RRSP + 4K paid down on mortgage vs. only 10K paid down on mortgage.
Yes, you bring up a good point…. your strategy is a popular one…and it may be right for some and it probably does work for some. The problem for me is that I don’t have many success stories to share… I haven’t seen it work with very many… For some reason, RRSP growth for many, has be minimal… there are other options to consider…
I am a CFP and while 2008, 2010 were not very positive for investors most of my clients that have been with me for a few years have seen compound returns in the 4-6% range. If your time horizon is less than 5 years you should not be in equity mutual funds to begin with.
In regards to DSC funds – they are really similar to the penalty of backing out of your mortgage early!! What is that all about! DSC funds should only be used for longer term portfolio’s (ie your retirement) as they provide a cheap way to buy and sell investments. The fund company compensates the advisor and the investors pays nothing assuming the funds are held for 6 years. (Similar to a mortgage Broker) The client can make switches during that period to re-balance or re-align a portfolio at no charge but if they redeem the funds then there is a charge. This declines over a 6 year period. This is no different then a mortgage. The broker is compensated by the lending institution for their work up front but if the mortgage is cancelled or replaced before the end of the term then there is a hefty penalty – usually a minimum of ~ $3,500.
If a client told me they would need the use of their money in a few years I would put them in low load funds (3 year deferral) or front end funds where there is no charge to sell and 0% – 5% to purchase. In addition they would be in a very low risk portfolio.
It is all about understanding the needs of the client and their risk tolerance.
My recommendation – put additional $$ towards your RRSP – use the tax refund to top up RESP and / or pay down Mortgage.
Appreciate your comments… and I do agree with some of what you say… except the mortgage penalty comparison… I’ll get to that later..
My readers, clients and friends have been telling me the same things… They invested for the long term… followed the rules of investing.. longer term investments should go into equities as they have performed well, historically.. But then the strange thing is that they would have been better off had they invested in a GIC because they really haven’t had any positive return over the last 10, 15 and even 20 year time frame… These are readers, clients and friends telling me this..
They have all experienced poor or negative returns over the past 15 years… I looked into why this happened and it’s not an easy question to answer… but maybe it’s because we had Giant corps go broke or were actually fraudulent…. Remember Enron, Worldcom, Lehman brothers, Bre-X, Tyco, etc.. they are plenty more… We don’t seem to factor om those corps anymore….
Here’s something that most of us don’t know…A great many corps, including the ones above, were part of the TSX, Dow Jones indexes but are no longer there…they just got removed… so how do you measure the stock market? And remember, they are still held in personal investment portfolios through mutual funds or maybe in stocks….. resulting in personal negative returns… at least for a great many of the people I speak with. So how can we look a TSX or Dow Jones stock index chart and say it’s outperformed real estate or other investments? I would think the only way would be to re-balance our personal investment portfolio constantly… or maybe just buy and index funds and forget about it…in which case you wouldn’t have to pay any DSC. Perhaps we just need to simplify?
The point is, these were all considered blue chip stocks… and widely held.. they are all bust… maybe we need to look at other investment options…. has anyone heard of real estate not performing well over any 7 or 10 year period? Or over any 20 or 30 year period? Ask that same question of your average Canadian’s investment portfolio and you’re likely to get a different answer… How many pension funds have you seen go bust? I say, it’s time to take back control…. and it can be done..
Regarding the penalty comment…. if people give you money, and you want it back, why should there be a 6 yr penalty? We can go to any ‘NO LOAD’ fund family and find similar funds that perform as well or better than any Deferred Sales Charge fund… and you get in and out after 30 to 90 days… NO CHARGE….
Mortgage penalties have been inflated for around 12 years… it’s well documented and I’ve written about this subject often… the calculation the Banks use, (not all lenders but all of the BIG SIX Banks) is unfair and could probably be challenged in court if someone had deep enough pockets to start that fight… Banks are charging unfair penalties that more than covers the Interest Rate Differential ( or cost to the Bank)…
Another alternative is to combine the options of mortgage prepayment and RRSP. If you have enough funds in your RRSP, you can pay down that higher interest rate mortgage to the bank and hold the mortgage in the RRSP, paying yourself back at a predetermined monthly rate. The money you save on a monthly payment can be put into the RRSP or further invested in other options such as income property investments.