Confused about your long-term investment goals? Here is a guide to making decisions about debt repayment, RRSP or TFSA contributions

Feb 22, 2013, 06:00 ET from CIBC

As the RRSP deadline looms, a new report by CIBC helps guide Canadians towards the answer

TORONTO, Feb. 22, 2013 /CNW/ - (TSX: CM) (NYSE: CM) - The number one question Canadians are asking this RRSP season is whether to pay down debt before contributing to their long-term savings says Jamie Golombek, CIBC's Managing Director of Tax & Estate Planning.

"It's the age-old debate - do you pay down debt or save for retirement? And where does a TFSA fit in? Canadians are increasingly dealing with more complexity in their financial planning choices," says Mr. Golombek. "While Canadians' current views are shifting towards debt reduction, this strategy may not necessarily make sense for everyone."

Mr. Golombek's new report, The RRSP, the TFSA and the Mortgage: Making the best choice, illustrates the various factors Canadians need to consider when making an informed decision - a decision complicated by increasing household debt, a low interest rate environment, and the introduction of the TFSA.

To maximize savings, the report recommends considering five key factors:

  1. The expected rate of return on your investments
  2. The interest rate on your debt
  3. Your current and anticipated personal tax rates
  4. Your time horizon
  5. Investment risk

"It's about making your money work harder for you. Factoring in these five key points can help you save thousands over the long term," said Mr Golombek. "Remember, it's not about making the perfect decision.  No matter the outcome, you will still be ahead of the game whether you choose to invest in an RRSP or TFSA or to repay debt, because you are saving for your future."

Due to the individuality of savings needs, Mr. Golombek recommends obtaining advice from a qualified expert. A CIBC advisor can help you evaluate different investment options, review debt interest rates and repayment considerations, and assess the amount of income that may be available to you in retirement.

CIBC is a leading North American financial institution with nearly 11 million personal banking and business clients. CIBC offers a full range of products and services through its comprehensive electronic banking network, branches and offices across Canada, and has offices in the United States and around the world. You can find other news releases and information about CIBC in our Press Centre on our corporate website at

Illustration of how to decide between the benefit of an RRSP, TFSA, and Debt Repayment

To illustrate this point let's take a look at an example. Suppose you have $1,500 of pre-tax earnings that is not needed to pay your monthly bills and an income tax rate of 33.33% today and an expected rate of 20% at retirement. After paying $500 (33.33% x $1,500) in current income tax, you will be left with $1,000 of after-tax cash flow that you can use to either invest in a TFSA or to make an additional repayment against your mortgage. Alternatively, you could contribute the entire $1,500 to your RRSP and pay no tax until the time of withdrawal. Suppose that over the long term, you expect to average a 5% rate of return (ROR) on your equity-based investments and have a mortgage with a 3% interest rate.

The chart below calculates the increase in your net worth under each of the three options.

Benefit after one year from RRSP, TFSA and debt repayment

(ROR = 5%, Interest rate on debt = 3%, Tax rate today = 33.33%, Tax rate upon withdrawal = 20%)

        RRSP           TFSA           Debt      
Income subject to tax       $1 ,500           $1,500           $1 ,500      
Income tax (33.33%)       NIL           (500)           (500)      
Plan contribution / debt repayment       $1,500           $1,000           $1,000      
Income earned (5%)       75           50           n/a      
Interest saved (3%)       n/a           n/a           30      
Value of benefit after one year (pre-tax)       $1,57 5           $1,050           $ 1,030      
Tax payable on withdrawal (20%)       (315)           NIL           N/A      
Benefit after one year (after-tax)       $1,260           $1,050           $ 1,030      

This example illustrates the impact that income tax rates, the expected rate of return on investments, and the interest rate on debt would have on your benefit after just one year.  To fully analyze your situation, you should project the benefit from an RRSP, TFSA and debt repayment over your time horizon.

You must also consider investment risk.  While you may be assured of saving 3% interest on your mortgage while this rate is locked-in, the rate of return on your investments may not be so certain.  Although the example assumes that your RRSP or TFSA investments would generate a 5% rate of return, this may certainly not be the case over a one-year period or even over longer periods of time since most equity-based investments do not provide a guaranteed rate of return. For a true comparison to the guaranteed interest savings on your mortgage, you should look to the rate of return on a risk-free investment, such as a Government of Canada bond, over the relevant time horizon.

Mr. Golombek offers additional scenarios in his report, The RRSP, the TFSA and the Mortgage: Making the best choice.