Pay Off Mortgage or Invest: What's Best as You Approach Retirement?
Retirement is approaching and you're finally able to ramp up your saving. Do you pay down your mortgage or invest? The years leading up to retirement are when income is at its highest and it's possible to save more. Clients will often ask me if it's better to pay off their mortgage or invest. While each option has benefits, it's important to consider your entire financial situation. Otherwise, you may take unnecessary risk or miss opportunities to improve your financial security.
Understanding Where You Are Now
Before looking at the details of this decision, there are a few priorities that you should tackle first:
Employer matching. Don't miss out on RRSP contribution matching if your employer offers it. Make sure you know the percent of matching and the dollar amount to max out.
Credit card debt. Pay off credit card or other high-interest debt before investing.
Emergency fund. As I talk about in this newsletter for Global News, having an emergency fund is crucial. An emergency fund brings peace of mind and allows you to avoid situations where you may have to take on high-interest debt or pay NSF fees. Having 3-6 months of cash in a high-interest savings account is a good target.
Once you have those items covered, you can start looking into the mortgage vs. investment comparison.
The first step to find which option is best for you is to take stock of your current financial situation.
Start by reviewing your mortgage details:
Mortgage information you'll need to make the comparison
interest rate
remaining term
pre-payment limits
expected interest rate when the term expires
Then take a look at your investments:
Assess your investments
What investments do you currently hold?
What rate of return have you earned in the past?
How much are you paying in fees?
What rate of return do you expect to earn going forward?
Once you know this information, you can start to compare the benefits of each option.
Benefits of Mortgage Reduction
It's simple. The benefit of repaying mortgage debt is easy to calculate. The financial return on your debt repayment is equal to the interest rate on your mortgage. Unlike investing, where returns are variable, the return on debt repayment is a sure thing.
It improves future cash flow. Once your mortgage is paid off, you'll no longer have this large regular expense. It sounds obvious, but this reduces your monthly cash flow needs. This is especially important for those who rely on variable investment income in retirement.
Peace of mind. Paying off the last of your debt can bring a great deal of relief. While some people are comfortable retiring with a mortgage, others may need to be debt-free before calling it quits. Even if the numbers work out to be better for investing, the peace of mind from being debt free shouldn't be underestimated. Financial planning isn't just about maximizing wealth, but instead aligning it with your priorities.
A mortgage calculator can help you compare different scenarios to see how much total interest you save from early prepayments.
While paying down debt is great, there are advantages to investing that shouldn’t be ignored:
Advantages of Investing
Higher returns. Investing in the stock market has the potential for higher returns. Just be sure to have reasonable expectations. While equity returns may be high, your investing results may be limited by your capacity to take risks. Being close to retirement, you will likely need to draw on the money soon, which means you won't be able to invest as aggressively.
Tax savings. Tax planning can increase the value of your savings. If you're in your peak earning years, you may be able to maximize the value of RRSP contributions. This is especially valuable if you expect your tax rate to be lower in retirement. Using spousal RRSPs can further help reduce taxes in retirement, but don't delay getting started to avoid the attribution rules.
Financial flexibility. Money used to pay down your mortgage becomes difficult to access for other needs. By investing, you give yourself options to use that money when you need it. This can be useful if you'll need cash flow early in retirement to delay the start of CPP.
Tailoring Your Strategy to Your Retirement Goals
There are pros and cons to each option so you should be clear on your values and goals before deciding. Be sure you can answer these key questions:
What are your financial priorities?
What is your risk tolerance?
What is your capacity to take risk?
Getting Professional Advice
If you're having trouble deciding which is best for you, know that help is available. A qualified financial planner can help with this and many more financial decisions.
If you’re feeling overwhelmed by all the work needed to create a plan, you can book a free introductory meeting with me.
