I’m a huge proponent of the Tax Free Savings Account (“TFSA”) and encourage everyone I know to stuff their TFSAs to the max. The beauty of this product is that money grows tax-free and you won’t owe any taxes on the growth of the money when you eventually withdraw it. You can fill it with the same investments that go into an Registered Retirement Savings Plan (“RRSP”) or a non-tax advantaged investment plan. This means you can put individual stocks in your TFSA. You’re free to stuff your TFSA with bonds, index funds, mutual funds, exchange traded funds (“ETFs”), guaranteed investment certificates (“GICs”) – any investment product your little heart desires!
At the same time, I’m a huge proponent of getting out of debt as fast as possible. I consider debt to be a cancer to your financial security. Instead of all your money working for you, some of your money has to go to someone else – your creditors – in order to make them rich or, atleast, financially secure. Debt sucks! You should get rid of it as soon as you can. Be it credit card, student loan, car loan, personal loan, line of credit – it doesn’t matter. Get debt out of your life and start keeping all of your money for your own dreams, goals, and priorities.
One day as I was encouraging a very dear friend to make use of her TFSA, she asked me point-blank whether contributing to a TFSA was the right move given that she and her husband – who also has an empty TFSA – were working on paying down their mortgage. “Is it better for us to pay off the mortgage or contribute to our TFSAs?” she asked me.
I was stumped! My two most basic financial tenets were at odds with each other, and I had no easy answer. But I’ve been thinking about her question for a long time… Here’s what I’ve come up with.
Once their mortgage is gone in roughly another 10 years, they can use their former mortgage payments to contribute to their TFSAs. They should be able to maximize investments in their TFSAs within a few years of paying off their mortgage because they are making significant mortgage payments currently. Mortgage-size contributions to their respective TFSAs will ensure that their available contribution room will be filled up very fast.
Secondly, the interest rate on their mortgage payment is fixed so they know how much their debt is costing them.
Thirdly, they’ll have to renew their mortgage atleast two more times before it’s gone and rates on mortgages are going up. By making extra payments to their mortgage principal balance right now, when their mortgage rate is low, they’re quickly eliminating the principal loan on their mortgage and minimizing the overall interest that they’re paying on that debt. They are also ensuring that their mortgage balance is as small as possible each time they renew at a higher rate. This diminishes the likelihood of facing higher minimum mortgage payments each time they renew their mortgage.
Fourthly, they both have pensions through their employers. Unless those pensions are reduced, my friends will have a steady income in retirement and may not need the added cushion provided by a big, fat TFSA. Stock market investing can be a roller-coaster and there is psychological value in sleeping well at night without worrying about money invested in the market. Paying down a mortgage delivers peace of mind since you know that you’re getting out of debt.
On the other hand…
The sooner money is invested in the stock market under the TFSA umbrella, the sooner they start benefitting from long-term investment returns that will more than likely be higher than the rate they are paying on their mortgage. The trade-off would be that it would take them more than 10 years to pay off their mortgage debt because the extra mortgage payments would be re-directed to investing within their TFSA. Keep in mind that there is no guarantee that the stock market’s returns will be higher – it’s a probability based on a review of returns in the past. As always, past performance is no guarantee of future returns.
Secondly, money that goes towards mortgage repayment cannot be accessed without taking out a home-equity line of credit or by selling the house. It’s essentially gone to the bank to repay the mortgage debt. Unless you’re willing to sell your home, you can’t get the money out of your house without borrowing it back from the bank. Money that is invested in the TFSA is far more accessible. You simply sell your investments and get the cash. I am not recommending that this be done – I’m just highlighting all the options.
Thirdly, investing with a TFSA increases the likelihood of a very comfortable retirement. My friends would still have access to their pensions. However, they might also benefit from having that big, fat TFSA that I mentioned earlier. It could be used for the little luxuries not covered by their pensions, whatever those may be. It could be used to help pay for their children’s university tuition or weddings.
Fourthly, my friends are in their late 30s and early 40s. Investing in the stock market now means a longer time horizon for systemic investing from their paycheques before retiring in their 60’s. Having their mortgage paid off in their 50s means that they’ll have maybe 10-15 of investing, rather than 20-25 years.
So at the end of the day, what do I tell my friend? Is it better to invest in the TFSA and anticipate higher returns over the long term, or is it better to make extra payments towards the mortgage and get rid of the debt as fast as possible?
Honestly, the decision comes down to my friend’s priorities. What is most important to her?
I can attest that a life without debt is fabulous! I was fortunate enough to pay off all my debt by age 34. I could have kept my mortgage until it ran its course, but I made a different choice for a few reasons. One, I really, really, really hate debt. Two, I knew that starting to invest in my mid-30s was a very good option to pursue in order to achieve my goal of a comfortable early retirement. Again, I was only 34 so I still had decades of investment runway ahead of me. Three, I didn’t understand the long-term returns of the market so I wasn’t in a position to make an informed decision about whether to risk my money by investing in the stock market. Looking back now, I’m fairly certain that my net worth would probably be significantly higher today if I’d invested in the stock market instead of paying off my house. I don’t regret my decision too, too much because I will still be fine and I have a mortgage-free home which will give me options when I need them.
If I could go back with the knowledge that I have now, I think a different choice would have been made. Based on what I’ve learned over the past 10 years, having money set aside in a portfolio while having a mortgage debt is the slightly better option. Why do I feel this way? I realize now that if I lost my home, then I would still have the money. When all of the money goes into the mortgage and the home is lost, then everything is lost – no home and no money! This is the worst of both worlds. Having the cushion of money allows for more options.
In my case, I was able to pay off my home at age 34 and then use gazelle-like focus to build my investment portfolio. If something had gone wrong before I’d built up my portfolio, then I would not have had sufficient money to keep my life intact while I dealt with whatever had to be addressed. If I had kept my mortgage over the last ten years, I would more than likely have benefited from the huge stock market run up that’s occurred since 2009. Those gains would have outstripped the mortgage interest that would have been owed.
They say that hindsight is 20/20 – they’re right. What do you think? Would you rather invest and stay in debt longer, or get out of debt first and then start investing for the future?