RRSP Catch Up
Life has moved quickly since Jeremy and Tina bought their house five years ago.
In 5 years, Jeremy and Tina have seen the value of their home increase from $500,000 to $700,000, despite recent weakness in the housing market they have been hearing about.
In addition, over these 5 years they have paid down the mortgage from $494,000 to $420,000 simply by making their regular monthly payments. They now have $280,000 of equity in their home.
They also have two young children.
With their mortgage up for renewal in the spring, Jeremy and Tina have questions about how their home equity can be used to achieve other financial goals. Specifically, Tina has now taken some time off work to be with their young kids, and with these increased expenses and reduced income they have fallen behind on retirement savings and not been able to start to save for the kid’s education.
We discussed refinancing the mortgage to $560,000, either by adding a line of credit or increasing the balance of the mortgage and using the $140,000 proceeds to diversify their home equity into other investments to save for retirement and begin investing for their kid’s education.
This strategy can greatly decrease the after-tax interest rate on your mortgage.
Jeremy has seen steady salary increases and expects his compensation to continue to increase from his current $120,000 (salary and bonus). We determined that by contributing $30,000 to his RRSP this year, and in future years enough to bring his taxable income down to $90,000 they will save at least $13,000 in income tax each year (and Tina will also receive child tax benefits).
Now with a hypothetical 3% interest rate on the new $560,000 mortgage, they will be paying $16,800 in interest each year and receiving a $13,000 tax refund each year. The net $3,800 in interest paid after the tax refund works out to a 0.68% interest rate after tax.
By accessing home equity to invest in their family’s future, Jeremy and Tina have reduced their after-tax interest rate from 3% to 0.68% (without mentioning the increased child tax benefits and education savings grant from the RESP contribution)
Let me know if you need a plan to lower your interest rate, reduce your taxes, and diversify your investments.
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