Juggling the Mortgage, RRSP’s and TFSA’s

Alright, I’m still wrapping my head around the idea of Tax Free Savings Accounts (TFSA) and what they mean to us in terms of our planning. So I don’t expect to get this all right in the first go, so here’s the deal. I’ll provide my first pass on what these mean to my plans and you can poke holes in my ideas and see if you can’t come up with your own. (Warning: These ideas are theoretical in nature so if I messed up please let me know with a comment.)

Right now I’m focusing on an interesting idea running around my head. You see when I get paid my salary I’m taxed at once, so when I buy an RRSP the government basically provides me a refund of the tax I paid on that money (but not my CPP or EI which are deductions and not tax). So at my 35% marginal tax rate every $1 I put into an RRSP generates $0.35, which almost brings me back up to my original $1.42 my company paid me for my time at work (but I can’t get back my CPP or EI deductions).

Now by putting that $0.35 I get back for my tax refund into a TFSA I’m now growing all $1.35 of my money without any further tax, until I take out the RRSP money. Except if I only take out the minimum deduction each year from my RRSP account when I’m in early retirement (which would be $10,100 this year – I’m only using the federal number here to make things easy to understand and I’m assuming no other income in my early retirement years). In that case I would pay no tax on any of my original $1.35 I put in both accounts. Following me so far? Good.

So basically by careful planning of using both accounts I can avoid ever paying a dime of tax on that original $1.35. Effectively I’ve made some of my income tax free (but not deduction free). This as a concept is VERY interesting to me. So now I’m faced with a thought, if I can make some of my income now tax free wouldn’t that mean I should try pour every dollar I can into a RRSP and then the refund into the TFSA?

If that is right, won’t it be a better to contribute to the RRSP and TFSA than paying down your mortgage? After all the mortgage is paid in after tax dollars, so wouldn’t I be ahead to have as much as possible tax free and pay off any mortgage balance I have from my TFSA when I retire instead of paying off the mortgage early? Yet if I do that I’m paying more in interest costs. Damn this is getting complicated and I haven’t even done the math yet.

Alright, let’s break out the calculators and do some math. I’ll start by saying I currently have about $143,000 mortgage balance and I’m currently paying it bi-weekly at 5.08% and it will be paid off in 15 years. This yields a payment of $522.27 every two weeks or $13,579.02 per year. This is situation A.

In situation B, I would reduce my mortgage payments once a month over 20 years, but with the same balance and interest rate. In this situation my payment drops to $945.88 a month or $11,350.50 per year. Then let’s assume I put the difference between the payments ($13,579.02-$11350.50 = $2228.52 per year) to my RRSP and then reinvest the $779.98 tax refund I get into a TFSA.

So in situation A I pay a total of $60,683.76 in interest over the 15 years of the mortgage and at age 45 I’m debt free. Yet in situation B I will pay $77,347.26 in interest and still have a balance of $50,089.70 to pay off from my TFSA at age 45. So if you take the difference between the interest costs of A and B that would be $77,347.26-60,683.76 = $16,663.50. Now if you add in my mortgage balance on B to that interest cost difference you get $66,753.20. So that’s the number to beat with my additional savings from putting the extra cash in B into my RRSP/TFSA.

Now let’s do the math on my additional savings in situation B. First the RRSP is getting an additional $2228.32/year or $185.71 a month. So assuming a 5% rate of return compounded monthly I will have an extra $45,701.46 in my RRSP account at age 45. Yet I also invested that tax refund of $779.98 per year in my TFSA. So let’s assume the same 5% rate of return and that results in an extra $15,993.42 in my TFSA at age 45. So in total that is an extra $67,009.34 in savings. So that just beats the cost difference between my mortgage options in the last paragraph.

So in general there are some minor possible savings there of $256.14, but not much given my assumed numbers. What would make this better would a higher return in your TFSA and RRSP accounts and a lower rate on your mortgage.

Yet one little thing to keep in mind, is in option B you would also reduce your yearly income to the government so if you are getting any child tax benefits those would increase a bit. Another issue is you would need to enough funds in your TFSA to pay off your mortgage in situation B, since the extra TFSA savings from the lower mortgage payments won’t be enough by themselves.

Obviously depending on your personal numbers this may or may not be useful. Doesn’t this seem very similar to the whole pay off your mortgage early or contribute to RRSP debate? *evil grin* But at least it is an interesting idea.

8 thoughts on “Juggling the Mortgage, RRSP’s and TFSA’s”

  1. I agree with your assessment of RRSP versus TFSA. For most people (it’s certainly true for me), the average tax rate on RRSP contributions will be much less than the average tax rate on withdrawals (esp. if you plan to retire early). So, it’s RRSP contributions first.

  2. This comment is also theoretical 😉 – so what if we will we be able to do a transfer in kind of non-registered funds into a TFSA closer to retirement in order to avoid taxation and wash non-registered funds like those of the Smith Manouvre or other non-registered investments – so if we have 100,000 of TFSA room we transfer in kind from the non-registered funds – then withdraw funds from the TFSA to avoid taxation and create room again to do it again the next year?

    That would mean that most couples would need to save less something closer to $70,000 a year (if they expected to have an income of $100,000 at early retirement) – since there would be no tax on the money from the TFSA.

    Would it work?

  3. Quentin,

    Not a problem. I did read your comment earlier, I was just rolling the idea around in my head for a while.

    I see what your getting at. You could just push off your capital gains until you could wash them in your TFSA and then pull them out to make more room again to repeat. I personally don’t see them allowing in kind contributions for this exact reason. It would be a huge loop hole to avoid tax.


    A T1213 would be a great idea to do if you have a regular contribution level and then you could move the money over to your TFSA sooner.


  4. CRA will allow transfers in-kind to the TFSA but will consider it a disposition. So you will be forced to realize a taxable capital gain using the asset’s market value at time of transfer. Hence no wash. “In-kind” only means you get to hold on to the asset, not that you avoid taxes.

  5. If your gross income is 100k for 2008 and you put 10k into your RRSP basically you get a 4k tax break. ( your income now becomes 4500. less.

    Over to the TFSA, do you get the same tax break?

  6. Rick,

    Actually if you put 10K into an RRSP your income becomes $10,000 less, hence the $4K tax refund.

    There is no refund for putting money in a TFSA, but it does grow tax free like an RRSP.


Comments are closed.