When a financial reporter posed the question to two certified general accountants – who know a thing or two about how to budget – one emphatically stated you should pay down your mortgage first, while the other suggested both paying down debt and saving.1 Proof that it’s not easy to answer this question!
However, Canadians have already decided the answer – and they’re taking action. According to the 2014 Sun Life Canadian Unretirement Index, more than half of Canadian mortgage holders are choosing to pay down their mortgage instead of saving for retirement:
The question begs, “Are they doing the right thing?” By taking a closer look at this conundrum and research revealing Canadians’ intentions, you’ll have more resources to advise your clients.
On average, Canadians expect only 10 per cent of their retirement income will come from home equity, with the other 90 per cent will come from sources such as government plans, personal savings and employer plans2:
Furthermore, more than half of Canadians say they have no plans to sell their property or take advantage of a reverse mortgage; only one out of four expect their home to be their primary source of retirement income.3
These results not only show it’s challenging to answer the age-old “pay off debt vs. save” debate, but also lead to another question: since only one out of four Canadians are making saving for retirement their top financial priority – and almost six out of 10 don’t plan to cash in on their home equity – how exactly will they pay for the retirement lifestyle they want to live?4
Not all of your clients will be able to live their vision of retirement, especially if they haven’t saved enough or they don’t have an employer pension. “About 39 per cent of working Canadians have a workplace pension plan – over six million. But coverage is falling. Back in 1997, 42 per cent of working Canadians had a pension plan”5 says Kevin Press, assistant vice-president, market insights, Sun Life Financial, and author of the Today’s Economy blog.
Another factor, economic reality, could force more Canadians to use their home equity for retirement income.
“Real estate will likely endure some difficulty with a slowing Canadian economy,” said Sadiq S. Adatia, chief investment officer, Sun Life Global Investments. “With an already overheated market, there may be additional pressures from upcoming retirees who feel they lack enough savings for their retirement. As a result, they may feel the need to downsize their homes for additional income due to these economic conditions.”
By outlining the pros and cons of using a home as the primary source of retirement income, you can help your clients focus on their financial priorities and help them make the right financial decisions.
Calculating the ideal approach
“There’s a simple way to look at this choice, assuming your clients’ mortgages allow them to pay more than their monthly or biweekly minimum,” Press says. “The decision boils down to whether they can earn more by investing than you would save by making extra mortgage payments.”
Press uses the example of a five per cent mortgage on the home. Payments are as good as a five per cent after-tax return on their money. Your clients lower the amount they owe the bank, on which they’re charged interest. They can budget for this expense, at least for the term of their mortgage.
Could your clients do better than five per cent by investing? Press said, “It’s possible.”
“The S&P/TSX Composite index was up almost 11 per cent for the year ended Feb. 14, 2014. But you can’t predict future returns based on past performance,” Press says. “So their decision will be driven at least partly by their comfort level with investment risk.” He adds that investments in a registered retirement savings plan can carry tax benefits, which make retirement investing a more attractive option.
The Pay off my mortgage or contribute to my RRSP? tool can help you explain the numbers to your clients.
Press said choosing between paying down debt or saving for retirement is a highly personal decision, and advisors can help their clients by asking other important questions. “Ask them, as they prepare for their retirement, ‘Do you have the plan in place?’ ‘Do you have a diversified set of investments to get to your retirement goals?’ And maybe counting on the home as that one and only or even that primary source of retirement income may not be the best solution.”
Best of both worlds
Improvements in personal financial behaviour emerged after the 2008 crisis; for example, 36 per cent are spending less and 25 per cent are saving more.6 This positive attitude presents an opportunity for you to discuss a dual approach to improving your clients’ finances.
You can show your clients the reality of their situation, by outlining all their potential sources of retirement income and highlighting any gaps between their actual income and desired income. Help them budget for both reasonable mortgage payments and saving more for their retirement.
As a next step, move the conversation to the benefits of the following solutions in providing retirement income, as well as explaining any risk or tradeoffs:
- Mutual funds – potential growth with varying levels of risk
- Life annuity – guaranteed lifetime income, not affected by market volatility, but money is locked in
- SunFlex Retirement Income – guaranteed lifetime income and the potential for market-based bonus income
- RRIF/LIF – your clients choose which registered funds to put into the RRIF or LIF and receive regular payments
Talking with your clients about their priorities and showing them various debt repayment and savings combinations will help them make the right financial decisions for their retirement planning. Most certified general accountants and advisors would agree that each plan you create with your clients will be different – as well as customized and appropriate for their distinct situations.
1 John Heinzel, “Should I pay down my mortgage or save for retirement?” Globe and Mail, February 14, 2013.
2 2014 Sun Life Canadian Unretirement Index.
3 2014 Sun Life Canadian Unretirement Index.
4 2014 Sun Life Canadian Unretirement Index.
5 Statistics Canada, as of January 1, 2011.
6 2014 Sun Life Canadian Unretirement Index.