Should you invest for retirement or pay off your mortgage? (2024)

Should you invest for retirement or pay off yourmortgage?

A recent poll discovered that Canadians’ financial priorities for 2023 had moved away from saving for retirement to paying off debt. This was no doubt fuelled by fears of a recession, high inflation and interest rates being the highest in over 20 years.

It makes sense then, that some Canadians would prioritize paying off their mortgage so they can join the 23.3% of Canadian homeowners who are mortgage-free. But does this strategy make financial sense? We look at the pros and cons of each option and explain how to decide on the best one for your personal circ*mstances.

The advantages of paying down your mortgage

A key advantage is paying less in interest, which could save you thousands of dollars. You’ll also free up future income that would otherwise go towards paying the mortgage, which could be particularly important for investors heading into retirement.

Once you’ve paid off your mortgage, you’ll have more money available to invest, which can very quickly boost your overall savings, plus you’ll have the peace of mind of knowing you fully own your home.

Also, building up equity in your home can give you quick access to more borrowing options, such as a low-interest home equity line of credit.

The downsides of paying down your mortgage

You’ll miss out on investment opportunities that could make you considerably better off: over the last couple of decades (when mortgage rates were typically considerably lower than returns from investments), it usually made financial sense to invest rather than pay off your mortgage.

By focusing on your home, you limit the diversification of your assets, meaning you could miss out on other opportunities. And, if the housing market were to fall, a large part of your assets could lose value for a considerable period of time.

You don’t have much liquidity when your main investment is your home: it can take a long time to sell it if you suddenly need access to a large amount of cash. However, having a home equity line of credit can reduce some of these concerns.

Depending on your situation, you could also miss out on potential tax savings. For example, business owners can often use some of the interest paid on their mortgage to offset against their business income, if they have an office at home. Also, any investor who saves within a registered account (such as an RRSP or a TFSA), can enjoy considerable tax benefits.

The benefits of investing your money

Stock market returns have, over the last 20 years, been considerably higher than mortgage interest. Over this period, investing typically provided Canadians with greater returns than the money they’d have saved by paying off their mortgage faster.

By focusing on investing, you benefit from compounding over the long term. Compounding is when you start to earn returns on the returns you’ve already earned, such as interest, capital gains and dividends. By reinvesting these returns, your money can grow much faster. For example, if you invested $100 monthly in the stock market (and averaged an annual return of 8%), after thirty years, your investment would be $114,000. Of that amount, three-quarters would be the result of returns earned, with only a quarter being the money invested.

Any contributions you make to an RRSP will reduce your taxable income, often leading to a considerable tax refund. Also, all income from your investments (including interest, dividends and capital gains) is tax-free in a TFSA, and tax-deferred in an RRSP (you pay tax on the income when you withdraw it).

Many companies offer retirement pension plans for their employees, whereby any contributions made are matched. This could effectively double the amount of money you save.

Investment also provide better liquidity. It’s typically very easy to turn your investments into cash if you ever need to, which is not the case with your home.

The disadvantages of investing your money

You’ll have a large debt for much longer, and for some it can feel a little precarious to not fully own your home, given the potential for the lender to repossess it if you default.

Nothing is guaranteed with the markets, but putting extra money into your mortgage will definitely pay it off faster. Even though the stock market has, in recent decades, delivered returns that have been higher than mortgage interest rates over the long-term, this isn’t guaranteed going forward.

For some people, investing in the stock market can feel stressful, even though, historically, it has always recouped its losses eventually.

The math behind investing versus paying off your mortgage

This mortgage example will give you a feel for what it could mean in dollars and cents to choose investing over paying off your mortgage:

• An outstanding mortgage amount of $500,000.
• A 20-year amortization (the total amount of time it will take to pay off the mortgage).
• A five-year term (the length of the current mortgage contract).
• Monthly mortgage payments.

Over that five-year term, if you chose to make additional monthly mortgage payments of $500, you’d save $5,254 in interest and would pay an extra $35,254 off the total amount owed.

If instead you invested that $500 monthly in a balanced portfolio of 60/40 equities and fixed income assets, at an average annual rate of return of 7%, you’d have returns of $5,799 and total investments of $35,799. In this scenario, you’d be $545 better off by investing.

This calculation obviously depends on a lot of assumptions. We used a 7% annual rate of return as a fairly conservative estimate of long-term returns for a 60/40 portfolio, taking into account potential fees and management costs of mutual funds.

Returns could potentially be higher, in which case the difference in the two strategies would be even greater, while the return could also be much less, depending on market performance. The main advantages of paying off your mortgage are a guaranteed reduction in the principal you owe and less interest paid.

Over the long term, investing your money rather than paying down your mortgage has usually been the better option, over the last couple of decades. But, when interest rates increase quickly, it’s not surprising that some homeowners focus more on paying off their mortgage.

It’s more complicated for business owners

If you’re a business owner, investing in your company would usually come before paying off your mortgage, given how this can greatly increase your income potential through:

• Expansion
• Boosting your marketing efforts.
• Increasing the number of employees.
• Growing your research and development activities.
• Launching more products.
• Buying more efficient equipment.

Also, if you’re paying more towards your mortgage, that money is almost certainly coming out of your company in some form or other. While it’s fine to use taxable income (such as the salary you pay yourself) to invest in an RRSP (because you’ll receive a considerable tax benefit) it may not be a good idea to use this money to pay off your mortgage. You’ll be paying it off with after-tax dollars.

Instead, it could make sense to pay off your mortgage with money from your company’s capital dividend account, which provides a tax-free way to take money out of your business. Cash from a company’s capital dividend account could come from any of these sources:

• Capital gains (the non-taxable half).
• Capital dividends from other companies.
• Payouts from employee life insurance policies.

Another advantage of not paying off your mortgage early is that you could offset some of the interest payment against your business income, if you have a home office.

The third way: investing for retirement and paying off your mortgage faster

A combination of both strategies is also worth considering, especially during times of high interest rates. You can grow your retirement investments and pay down your mortgage faster, and there are tax breaks to help you do it.

Let’s consider our earlier example: if you invested that extra $500 monthly into an RRSP, you’d have $6,000 taken off your annual taxable income. If you pay tax at source and have a marginal tax rate of 31%, you could get a tax refund for as much as $1,860. If you’re in a province’s highest marginal tax rate of, for example, 53.5%, you could get a tax refund for as much as $3,210.

If you use that money to pay off a lump sum of your mortgage, you’ll get the best of both worlds: you’ll maximize your retirement savings and reduce your mortgage debt.

Which is the best option for you?

This is a complex question, and the answer should consider these aspects of your personal circ*mstances:

• Your age and income.
• Your long-term investment goals.
• Your risk tolerance level.
• If debt makes you feel anxious.
• Your mortgage interest rate.
• Current opportunities in the stock market.
• The stage your business is in (for business owners).

Having a financial advisor is crucial when making this kind of decision. Your IG Advisor will consider all the options within the framework of your overall financial plan. They’ll then advise you on the best and most tax-efficient course of action for you.

If you’re wondering whether to pay off your mortgage faster or grow your retirement savings, call your IG Advisor today to set up a meeting to help you make the right decision. If you don’t have an IG Advisor, you can find one here.

^{Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circ*mstances from an IG Wealth Management Consultant.}

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