By Julie Cazzin with Brenda Hiscock
Q: I’m 52 years old, married and have a 12-year-old daughter. Our gross household income is $130,000, and I have a $220,000 mortgage at about four per cent. We have not contributed to our registered retirement savings plans (RRSPs) in 15 years and have not started tax-free savings accounts (TFSAs). We only have savings of about $40,000 for emergencies and it’s sitting in a bank savings account in cash, as well as a registered education savings plan (RESP) that we fully contribute to annually for our daughter. Recently, we inherited $260,000 from my father who died last year. What’s the best thing to do with this money? Should we pay off the mortgage, contribute to RRSPs or start TSFAs? — Reggie in Moncton, N.B.
FP Answers: My sincere condolences to you and your family on your father’s death, Reggie, and thank you for your question.
With an inheritance of $260,000 and $40,000 in cash in a savings account, you have a total of $300,000 in cash to invest. A simple solution would be to pay off your $220,000 mortgage in full. That would leave $80,000 to contribute to RRSPs and TFSAs. The increase in cash flow from no longer making mortgage payments will result in more money to contribute to these accounts going forward if you’re hesitant to invest it all at once.
You mention that your mortgage is at four per cent, so it is likely a fixed-rate mortgage, which tends to have higher penalties if paid off early. That penalty could have been quite high six months ago when interest rates were low, but it is likely much less now.
Fixed-rate mortgages generally have either a three-month interest penalty or an interest-differential penalty (your mortgage rate compared to current mortgage rates, which have now gone up, thus decreasing this penalty). You should inquire with your lender as to what the penalty might be prior to making any prepayments.
If the penalty is too high to pay it all off, you may consider lump sum prepayments (often 10 per cent to 20 per cent of the original mortgage) as well as doubling up on payments (a common mortgage feature), and then paying it off in full at maturity. Your lender will be able to let you know those options. If you have a high tolerance for risk, consider investing the majority of the funds instead of paying off the mortgage.
You indicate that your gross household income is $130,000, but I am uncertain of the income split between you and your spouse. If you earn $65,000 each, then you are both in a modest tax bracket and RRSP contributions could be somewhat beneficial. If one of your incomes is significantly higher than the other, focus RRSP contributions in the name of the higher-income-earning spouse. If income is significantly higher for one spouse, and early retirement is being considered, you may want to consider contributions to a spousal RRSP. This may allow you to better equalize your incomes before age 65.
There are also company savings plans to consider. If they are available to you or your spouse, any company matching plans should be utilized to maximize savings opportunities. In addition, group savings plans often carry low investment fees.
You indicate that you have not contributed to RRSPs for 15 years. Since there may not be a benefit in reducing your incomes below $50,000 of taxable income, because the tax savings may be similar to the tax you will pay on withdrawal, you can use that figure as a rough benchmark when considering how much to deposit.
Keep in mind, you can contribute to an RRSP in one year but you do not need to deduct the whole contribution in that year. Some can be carried forward to deduct the next year, an attractive option if the tax savings will be higher.
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Any funds not otherwise contributed to RRSPs should be contributed to TFSAs, including the emergency fund money, so at least the funds are growing tax free.
If you decide to repay your mortgage, the end of those payments means you will have extra cash every month. It will be important to determine how much of that extra money should go to savings, or whether you can afford to spend more in other areas.
In other words, if you and your spouse are on a good trajectory for retirement, maybe this windfall allows you to spend a bit more on yourselves or your kids.
This could also be a good time to consider retirement planning, set some saving and spending targets, and see what is possible for you. The loss of a loved one is a good time to consider your own estate planning.
There is really no bad choice for you to make here, Reggie. Both debt repayment and investing help in building your net worth as you work towards financial independence and retirement.
Brenda Hiscock is a fee-only, advice-only certified financial planner with Objective Financial Partners Inc. in Toronto.
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