RRSP or mortgage: why the math isn't the whole answer

At a 5% mortgage rate, paying down your mortgage is a guaranteed 5% after-tax return. Your RRSP might earn 7% over time, but markets don't guarantee anything. So mortgage first, right?

Not necessarily. The RRSP gives you something the mortgage payment doesn't: an immediate tax refund.

Say you're earning $80,000 in Ontario. Your marginal tax rate is roughly 31.5%. Put $10,000 into your RRSP and you get about $3,150 back from the CRA. That refund happens this year - not in 30 years when you retire.

Now the comparison isn't $10,000 at 7% versus $10,000 at guaranteed 5%. It's $10,000 at 7% plus $3,150 cash today versus $10,000 at guaranteed 5%.

What you do with that refund matters. Spend it on a vacation and the mortgage wins. Put it toward the mortgage and suddenly you've paid down $13,150 of debt for $10,000 out of pocket. The effective rate of return on mortgage paydown just jumped from 5% to about 6.6%.

Or you could invest the refund. Take that $3,150 and put it in your TFSA where it can grow tax-free. Now you've got $10,000 growing in the RRSP and $3,150 growing in the TFSA, all for the same $10,000 you would have put toward the mortgage.

The math gets messier when you factor in that RRSP withdrawals get taxed later. If your retirement tax rate matches your current rate, it's a wash. If you retire to a lower tax bracket - which most people do - the RRSP wins bigger. If tax rates rise across the board by the time you retire, the mortgage strategy looks better.

Your mortgage rate matters too. At 3%, the RRSP usually wins even without perfect refund discipline. At 6%, the guaranteed mortgage paydown starts looking pretty good. TaxSplit.ca will show you exactly what that refund is worth at your income and province - the number shifts significantly between Alberta and Quebec.

But here's what the pure math misses: paying down your mortgage frees up cash flow every month once it's gone. The RRSP keeps your monthly payments the same until retirement. If you're stretched thin now, that monthly breathing room from mortgage paydown might be worth more than the optimal long-term return.

The other thing the math misses is that most people don't actually invest their tax refund. They spend it. If you're honest about your own habits and know the refund will go toward something you'd buy anyway, the guaranteed mortgage return starts looking a lot more attractive.

If you're deciding this year: RRSP usually wins above $60,000 income if you'll invest the refund or put it toward the mortgage. Below $60,000, or if the refund will get spent, pay the mortgage first. At mortgage rates above 5.5%, lean toward the mortgage regardless of income.

The exact break-even point depends on your tax bracket, your mortgage rate, and what you actually do with that refund check.