Should I Contribute to My RRSP or Pay Off My Mortgage?

Ask MoneySense

We have a small mortgage, only $80,000, coming up for renewal. We have some money (approximately $25,000) that we can either put on the mortgage or invest or put into our RRSP. What is the best way to go?

—Linda

Which should Canadians prioritize: RRSP or mortgage?

Most working Canadians carry some debt and also have room to save in accounts such as registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs). Employer plans with matching contributions can further complicate the decision. Directing your cash flow in the most effective way is a key part of sound financial planning.

In your case, Linda, you describe the mortgage as “small.” That is a useful starting point because how you feel about a debt can shape your priorities. If the mortgage balance feels manageable compared with your home’s value and your other obligations, putting money into savings or retirement accounts may be reasonable. If, instead, your equity is thin and you feel financially exposed, paying down debt to build a buffer could be preferable.

Comparing mortgage interest to investment returns

A practical way to choose is to compare your mortgage interest rate with the after-tax return you expect from investing. For example, if your mortgage costs 5% annually, you would need to generate at least a 5% after-tax return from investments to make investing more attractive than paying down the mortgage. But the comparison isn’t always this simple.

Investment returns are taxed differently depending on the account. Earnings in a TFSA are tax-free, so a 5% return is a full 5% benefit to you. Returns in a non-registered account are taxable, reducing the effective return. RRSPs provide tax deferral, and you also receive an immediate tax deduction on contributions; however, withdrawals are taxed later. Account type matters a great deal when you measure the after-tax benefit of investing versus the guaranteed “return” from reducing mortgage interest.

Before choosing where to put your $25,000, check how much RRSP and TFSA contribution room you have available. If you have unused RRSP room and expect to be in a lower tax bracket in retirement, the RRSP may be especially attractive. If your TFSA room is available, that account offers tax-free growth plus the flexibility to withdraw funds without tax if you later decide to pay down the mortgage or use the money for another purpose.

Considering the tax implications of investments

An RRSP contribution of $25,000 will create a sizable tax deduction. That deduction’s value depends on your current marginal tax rate. If one spouse earns substantially more than the other, it usually makes sense to claim RRSP contributions in the name of the higher-income spouse to maximize tax savings. You can also choose when to claim the deduction: you can make the contribution and defer the deduction to a later tax year if that produces a better tax outcome.

For example, if a large deduction would push you into a lower taxable-income bracket this year, it may be advantageous to spread the deduction across years or to carry it forward and claim it when your marginal rate is higher. The mechanics are straightforward: you make the contribution and preserve the deduction until a year when claiming it yields the greatest benefit.

TFSA vs RRSP

RRSPs can be very powerful when you expect to be in a lower tax bracket in retirement, or if you want to take full advantage of the immediate tax deduction and then let the funds grow tax-deferred. Conversely, TFSAs offer complete tax-free growth and withdrawal flexibility. A TFSA can function as a staging account: you can park savings there, earn tax-free returns, and later decide whether to use the funds to pay down mortgage debt or to convert them into RRSP contributions.

Because of the TFSA’s flexibility, it can be appealing if you anticipate needing access to funds in the short or medium term or if you wish to retain the option to pay down the mortgage later without tax consequences.

When an RRSP makes more sense than paying off a mortgage

Given the information you provided—an $80,000 mortgage and $25,000 available to allocate—I would lean toward recommending an RRSP contribution if your accounts are not already maxed out and your mortgage truly feels manageable. A substantial RRSP contribution can provide significant tax relief today and meaningful growth over the long term, especially if you are in a relatively high tax bracket now and expect lower income in retirement. If you have an employer match in a workplace plan, always prioritize that match first since it is essentially free money.

That said, both choices are valid. If reducing monthly payments or lowering debt makes you feel more secure, applying some or all of the funds to the mortgage is a perfectly reasonable approach. If you prefer to retain flexibility, contributing to a TFSA gives you the option to later direct those funds toward the mortgage, an RRSP, or other needs.