Most of us feel that by the age of around 30 we will be well on our way to saving. The reality is usually completely different. You’ll likely struggle to keep a lot of eggs in the air – mortgage payments, the huge expenses of a growing family, and the increasing responsibilities of a busy career. Your income probably isn’t very generous and there may not be much money left for savings. In fact, you may find that you are constantly trying to meet several financial requirements. Is it worth paying off a mortgage? Saving for your children’s education? Or putting money into an RRSP?
It takes a little planning to make the right choice. There is no right answer for everyone and a lot depends on your priorities and the setbacks you encounter along the way. Just ask Scott and Erin Parkin of Brantford, Ontario. Erin, 33, has been a homemaker and parent to her two children, Owen, 10, and Molly, 6, for the past 10 years. Scott, a 39-year-old engineer, is a sole earner, and because he is in a high tax bracket, he has always contributed to RRSPs – his own plan plus Erin’s spousal RRSP. Over the years, they have accumulated $66,800 in Scott’s RRSP and $20,000 in Erin’s RRSP.
However, in 2009 these payments ended. This is because the Parkins family is not comfortable with how they invest their RRSP money. Their entire portfolio consists of segregated funds with annual fees exceeding 3% and they don’t know what to do with it. But the more important reason is that they are trying to maintain their $198,000 mortgage payment over 15 years. “The little extra money we have – about $3,600 a year – goes towards the mortgage,” Scott says.
The couple also says they could probably squeeze an extra $200 a month from their budget to put toward an RRSP or mortgage, but they’re not sure which option would be best. These competing priorities are typical of people in their 30s. “It’s a constant battle,” Scott says.
Megan and Matthew Shaw of Thunder Bay, Ont., share the Parkins’ concerns. They are also trying to start a family (they have three children, ages 9, 4, and 2) and are paying off their $99,000 mortgage solely on Matthew’s $85,000 salary. (Names have been changed to protect their privacy.) “We don’t have any consumer debt, so we’re happy with that,” says Matthew, 35, a police officer with six years of experience. “But after expenses, we usually have about $5,000 a year to invest and we don’t know where to put that money – mortgage or RRSP?”
What makes this decision more galling is that the Shaws don’t know how to fix the stagnant returns on their $150,000 RRSP savings. They feel they need a completely new strategy. “Why are we putting all this money into RRSPs and not getting any return?” asks Megan, 38. “Our annual fees, which average around 2.8%, are ridiculously high.”
The Shaws feel stuck. Most of their mutual funds have deferred sales charges (DSC) – a penalty you pay if you sell the fund before a certain number of years. These fees usually drop to zero after seven years, but can be high before then. “We are debating whether to give up, sell the funds and pay a penalty that could be several thousand dollars,” Matthew says. “Or should we wait and sell them when the deferred sales fees reach zero in a few years? We just don’t know.”
What the experts say
In your 30s, like Scott and Erin Parkin and Megan and Matthew Shaw, you often feel frustrated that you’re not making much financial progress. The good news is that focusing on paying off your mortgage is an excellent strategy. “It’s a risk-free, highest-return investment the average person can make,” says Schlenker, the planner. “Most mortgages allow for additional principal repayment, up to 10% of the balance, on anniversary dates. Take advantage of this opportunity.”
However, if saving is a huge motivator for you, it may make just as much sense for you to contribute to an RRSP. “Mortgage vs. RRSP? I hear this question all the time,” says Lamontagne. “If it’s a purely financial decision, typically high-income earners in the highest tax brackets should maximize their RRSP room before making additional mortgage payments,” Lamontagne says. “The key is not to issue this refund. If the Parkins put the refund back into their RRSPs or even use it to pay off their mortgage, they will grow their savings.
The way in which existing RRSPs are invested should also be changed. Parkins and the Shaws put their savings into expensive investments, and the costs of their funds reduce their profits. “In reality, investors can only control two things that affect the returns on their investment accounts – their own behavior and the fees they charge,” Schlenker says. “Both Parkins and the Shaws pay fees of $3,000 to $4,000 a year, which is much more than seems reasonable.”
Lamontagne agrees. “If they can reduce costs by even 0.5%, they will have thousands of dollars more in their accounts by the time they retire.” Parkins and the Shaws should start looking for a fee-only advisor, not one who receives a commission on the funds they sell. Ideally, an advisor should use low-cost ETFs or index mutual funds to build their RRSP portfolios.
In the Shaws’ case, they can start the transition by moving at least some of the money from their mutual funds. You can usually transfer 10% of the balance each year without incurring deferred sales fees. The low-fee investment portfolio consists of 60% equities and 40% fixed income – similar to a low-fee investment portfolio The meaning of money Sandwich portfolio – this is a good start.
Finally, the Shaws need to realize that police officers like Matthew can draw a very generous pension when they retire. This means that having a large RRSP would result in that money being highly taxed when mandatory withdrawals begin at age 72. So a better option for the Shaws may be to use the extra money to pay off the mortgage and max out their TFSA before they earn more in the RRSP.
