RRSP Q&A: Should I use my refund to pay down debt?

From February 16 to 19, 2010, MoneySense.ca’s top financial planners are answering your RRSP questions. For the full list of questions answered — or to submit a question of your own — click here.

I am 46 years old, single with no children and I will have a good pension when I retire, as I am a teacher. I am contributing to RRSPs but I also have a mortgage and line of credit that I am paying down. The RRSPs are a tax break for me but should I be using that money for debt reduction right now? — Heather

Barbara Garbens: It sounds like you’ve been taking advantage of the wonders of compounding by contributing to your RRSP and watching your money grow over time.  Everyone’s situation is different, but generally speaking, a good strategy is to contribute to the RRSP and use the tax refund to make an additional payment on your Line of Credit or mortgage (whichever one has the highest cost and assuming that you have prepayment privileges on your mortgage).

You indicate that you will have a good pension when you retire and yes, generally teachers’ pensions are good and the funds well managed so that you reap the benefits of market growth etc.  If you have done a detailed cashflow analysis of your longer term needs, you will know if the pension (which will be indexed) will be enough to cover your post retirement spending patterns.  This is key.  If the pension will do the trick by itself, you may want to divert some of the RRSP contribution money to the mortgage/LOC now in order to free up monthly cashflow sooner once the debt is paid off.  Once paid off, this extra cashflow could go toward the RRSP room (if it has not been maximized), towards the new TFSA or even just towards yourself (vacations, etc.)  There are also other considerations such as how big the RRSP will get and whether you will be in the same or a lower bracket when you withdraw the money.  This may make a difference as to your decision as to how long to contribute to the RRSP and at what level.

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