This million dollar question that has been asked over and over again. Everyone wants to know. At some point your friends or family asked. Media has debated this golden question many times. Even your advisor has shared their two cents on this issue. Everyone wants to know. There are many different answers, depending on who you ask. Which ones are right? Which ones are wrong? Everyone is entitled to their two cents. There is good news though, building your retirement plan or paying down debt are both solid options.
Keeping that in mind, everyone’s situation is a little different.
Mortgage vs RRSP. TFSA vs Student Loan. Credit Card Debt vs RRSP. TFSA vs Mortgage. RRSP vs Car Payment. Lots of different situations, some of us are in one of these and others may have two or more different forms of debt to pay down.
Since everyone’s circumstances are different, you can use this guideline to decide on whether to tackle your debt or keep funding your retirement plans:
If the rate of return on your investment(s) you make with your TFSA or RRSP account is higher than your debt interest rate, well the easy option is to keep funding your TFSA or RRSP. However, if your rate of return on your investment(s) is lower versus your debt’s interest rate, the obvious choice would be to pay down your debt first.
So, should you keep funding your TFSA or RRSP accounts versus paying down your 18 percent credit card debt? I think the choice is pretty easy here. Unless you’re returning 18 percent annually from your investments in your TFSA or RRSP, go ahead and pay off your credit card debt.
I took the route of paying off my credit card debt last year. I strictly focused on my credit card debt. It only made sense to me and my situation. I do not carry any investments and even if I did carry some, I highly doubt that they would be returning 18 percent. And to be quite honest, I don’t know anyone online or in real life who is returning 18 percent annually from their investments. I’m sure there are the fortunate ones who return that even in turbulent times that we are in today.
My pay-down rate of return was my 18 percent credit card interest rate. Even when I lowered my credit card interest rate to 11 percent, the pay-down rate of return was still solid. By paying off my credit card slowly (in 347 days) I returned well over 11 percent last year on my credit card debt.
So, let’s take this a step further.
Let’s say you’re financing a new car and you want to fund your TFSA or RRSP account. That depends strictly on your car loan interest rate. If you’re getting a low interest rate, under 4 percent, then the obvious would be to go with your TFSA and/or RRSP. However, if your car financing interest rate is at 7 or 8 percent, I would say it would be tough for you to return that much on your investments. It certainly is not impossible, but the risk level is quite high.
How about the mortgage. Let’s say that you are like me and have a 3.5 percent mortgage rate. The obvious would to invest in your TFSA and/or RRSP account. We are fortunate to have fairly low mortgage interest rates today. This gives us ample opportunity to fund our retirement plans. I will also add this: It’s never a bad idea to pay down your mortgage. The after tax return is always fairly good.
Can you fund your retirement plan and pay down your debt at the same time?
Absolutely. I did both last year and managed to pay off my credit card debt in less than a year. I’m still not debt free, but that’s fine with me, it’s about the baby steps and moving in the right direction. In my instance, I focused on the highest debt. I knew it would give me the best return. Despite having (and still do) LOC debt, I chose to pay off my credit card debt.
And while paying down my credit card debt, I kept funding my TFSA account and RRSP account. I did not contribute a lot, but something is better than nothing for me. I am still in rebuild mode and trying to become debt free. I also continued to pay my mortgage, even though I did not contribute any extra payments. I’m in no hurry to pay off my mortgage, partly because my focus is elsewhere (eliminating LOC & funding my retirement plan) and because I’m comfortable with the equity in my home that I’ve managed to build up in a short period of time.
So, what should you do first, pay down your debt or fund your retirement plan?
Both moves are excellent. Pick the one that’s right for your situation, do what’s best for you and see if it’s possible in your unique scenario to fund your retirement plan while paying off your debt. Procrastinating is your biggest enemy. The longer you take to decide on what to do, the more of a negative effect you have on your situation. Decide what to do and get to it. You’ve got nothing to lose and everything to gain.
So, what are you waiting for? Get to it!