Financial Planning Q 'n A

A question which often arises is what to do with an extra amount of money available each month or once a year. The most common situations being a raise in earnings, a year end bonus or a windfall. Reducing your mortgage or increasing your RRSP contributions are both good financial planning options. Paying down your mortgage creates a known, low risk rate of return based on the interest rate of your mortgage. Contributing to your RRSP may or may not create a rate of return based on your investment performance.

As a simple example, a person in a 45% tax bracket with 5% mortgage will, by paying down that mortgage get an equivalent pre tax rate of return of 9 percent if that same money earned interest, or approximately 6.5% if that money earned capital gains. In making your decision, you would consider the potentially higher returns and higher risk in your RRSP with the lower return, lower risk option of reducing your mortgage.

Some individuals choose both and split the difference, using a portion of their additional funds for RRSP’s and a portion for debt reduction. If you have high interest rate consumer debt, there is a very strong case for reducing that debt before either of the above options.