Month: May 2016

Are you planning for retirement? Have you started to save? Do you know how much you need? If not, then today’s podcast is for you. My guest, David Trahair, stops by to discuss his new book, The Procrastinator’s Guide to Retirement: How You Can Retire in 10 Years or Less, and provides tips for Canadians who’ve delayed saving for retirement.

How Much Do You Need?

Listed in the table below is the maximum amount a single person can receive from government pension plans as of 2016.

While this is a decent amount, it assumes that the pensioner who receives the maximum has worked 39 years between the ages of 18-65 and made the year’s maximum pensionable earnings amount ($54,900 for 2016). Unfortunately, most Canadians do not fall into that category. David notes:

The average according to Service Canada is about $7,500 a year from the average person who’s already collecting the Canada Pension Plan.

To truly know what you need to save up for retirement, David suggests tracking your spending for a month. He recommends a free tool from Mint.com that can track your spending and categorize where your money goes. Alternatively, for those that are nervous about their banking information going to Mint.com’s server and cloud, I suggest tracking one month with pen and paper, if you do not like to use a spreadsheet.

Or download our free excel budgeting worksheet.

By tracking your spending, you’ll have an idea of how much you need in a month to cover your expenses.

Moreover, David doesn’t think you need to save $1 million for retirement. Instead he recommends:

What I’m saying is that if you are prudent with your money and essentially that’s as simple as spending less than you make and not running up debt so there is something to save for retirement. Factor in what you’re spending is, look at what you and your spouse, if you have a spouse, is going to get from CPP and Old Age Security and then look at the difference between your estimated spending adjusted for inflation and what the government pension plans are going to pay you. And then good news for many people is that differential is not that huge, so it’s not a million, it’s something much more attainable.

He also says the concerns that there will be no pension left for Gen X and Millennials is not true. The Canada Pension Plan is currently fully funded for the next 70 years, even when you consider our aging population.

What if I am in debt and planning for retirement?

Before you start saving for retirement you need to get out of debt, especially credit card debt.

It doesn’t make sense to save $200 a month to put into a RRSP, when you have credit card debt with 20% interest.

He also cautions against using your house for your retirement because you cannot take $10,000 out of your home when you need it. A house is a good asset, but you need cash flow in your retirement.

What if I am only a few years from retirement?

David recommends focusing on discretionary expenses like eating out, clothing, and cash withdrawals to free up money that can be put into retirement savings. Again, he suggests tracking your expenses, so that any excess money can go into your retirement. In addition, start acting like you are retired, even on a part-time basis. This will help you determine what you will be doing while you’re retired and if you need to save more than someone who will work part-time in their retirement.

How to prepare for retirement

Here are David’s recommendations for retirement planning:

• Rules of thumbs are too general for retirement planning
• Track your spending
  • This will give you an idea of what you need in the future
  • Reveal any debts that need to be paid off
  • Find saving opportunities and areas where you can reduce discretionary expenses
• If there are debts, pay them off before you retire – including your mortgage
• Start practicing for retirement now

If you find your debts are unmanageable and you will not be able to pay them off before retirement – get professional advice from one of the licensed insolvency trustees at Hoyes, Michalos & Associates. Your first consultation is always free.

Read the full transcript of today’s podcast below.

Resources mentioned in the show

• The Procrastinator’s Guide to Retirement: How You Can Retire in 10 Years or Less
• David’s other books
• Crushing Debt. Why Canadians Should Drop Everything and Pay Off Debt Podcast
• Mint.com

FULL TRANSCRIPT show #90 with David Trahair

Doug Hoyes:  Today we’re going to talk about retirement and more specifically is it possible to retire in the future if you have debt today. My guest today is David Trahair, who was my guest way back on show 25, back in February 2015 and this is show number 90, so it’s been well over a year since David was first on the show. And on that show we talked about his book Crushing Debt, Why Canadians Should Drop Everything and Pay off Debt. I’ll put links in the show notes hoyes.com to that show and links to David’s books.

Today David is back and he just released a new book called The Procrastinator’s Guide to Retirement: How You Can Retire in 10 Years or Less. I’ve read the book, it’s got some great advice in it so let’s talk retirement.

David, welcome back, thanks for being here. So, in Canada we have CPP and OAS and GIS. So, I would assume retirement shouldn’t be a big worry and yet you wrote a book on it. So, are you worried about Canadians being ready for retirement?

David Trahair:  I think generally, yes. I’m worried for a lot of Canadians. But let’s focus on the government pension plans for a minute and throw out some numbers. In 2016 the maximum Canada Pension plan is $13,110 a year, Old Age Security, $6,846 a year. So, you combine those, $19,956 just under $20,000 for a single person if they’re maxed out on Canadian Pension Plan. So, a couple that’s $40,000 if they’re maxed out. That’s a pretty good basic retirement pension, it’s a defined benefit pension backed by the Canadian government, adjusted for inflation. That’s a pretty good basis for retirement.

So, people, lower income people who are in that boat might be fine just on the Government Pensions alone. The problem I think is middle income, higher income people who need much more than that and are woefully behind in their savings, their retirement savings are just woefully inefficient for their lifestyle.

Doug Hoyes:  So, how do I know then what I’m likely to need if I retire? So, you’re saying that if I’m maxed out for CPP, in order to be maxed out that would mean I had to have worked for a certain number of years.

David Trahair:  39 years from age 18 to 65, yeah.

Doug Hoyes:  Got you, okay. And is there, do I have to have earned a certain amount of income during that time period too?

David Trahair:  Yeah, basically it’s tied to the year’s maximum pensionable earnings amount. So, for 2016 it’s about $54,900. Anybody earning a salary of that level or higher will be paying the maxim into the pension plan. So, you would be – the problem is most Canadians haven’t been. The average according to Service Canada is about $7,500 a year from the average person who’s already collecting the Canada Pension Plan.

And that’s the main point I have, when projecting how much you’re going to need when you retire, there’s an easy way and a hard way. The easy way is relying on rough rules of thumb. Many of your listeners probably have heard of this idea that you need approximately 70% of your pre-retirement earnings to maintain your standard of living. That’s just a rough wild guess that may be right for you but may be totally inaccurate. A much better, and it is a harder way because it requires some more work, is to base your retirement spending on your current spending.

And this is the key I feel to retirement planning as well as many other issues related to personal finance such as getting out of debt, is, I try to encourage people to track their personal spending. Track where their personal money is going because that is their fingerprint. You know, rules of thumb are dangerous because each of our personal financial situations are different. So, I try and encourage people to track their spending now and project into the future.

Doug Hoyes:  Yeah. Because I guess if I live in downtown Toronto or if I live in a small town somewhere else, my needs are going to be different. Am I going to need a car when I’m retired or not? Am I going to still be buying a suit every six months to go to work or will I not? So, I have to track what I’m actually spending now. So, if I have no clue what I’m spending on groceries now, then how am I going to project what I’m going to be spending on groceries when I’m retired. It’ll probably be a pretty similar amount I’m guessing.

David Trahair:  Exactly.

Doug Hoyes:  I’m probably still going to eat breakfast when I’m retired.

David Trahair:  That’s right.

Doug Hoyes:  But then I also have to take that next step and say okay when I am retired where will I be? Am I going to still be living in this same town? Am I going to live somewhere else? What is going to change? So, you actually recommend getting out a piece of paper or a spreadsheet and actually writing down here’s what I spend my money on.

David Trahair:  Yeah well there’s several ways to do it. Appendix One of the book takes people through the process of downloading the information from their bank accounts, from their credit cards into a spreadsheet and then sorting it in that manner. Now I’m more than aware that most Canadians aren’t accountants like us, and that would be torture for them. So, there are other alternatives. One of the ones that I recommend in a book is a website called Mint.com from Intuit, makers of QuickBooks software. And I don’t have a business relationship –

Doug Hoyes:  You don’t get paid by Mint for saying that.

David Trahair:  I don’t, I don’t. But it’s an amazing service. It’s a free service whereby you download or have Mint.com the website download all your banking information automatically on to their server, it’s in their cloud. So, you have to get over the security controls and make sure you’re comfortable with the security controls of Intuit before you do this. But if you can get over that, the reporting is absolutely fantastic.

One of the reports they have is a donut chart, a multi coloured donut chart showing the categories of your spending from the biggest to the smallest in colour. And if you click on any parts of the chart it’ll give you the source data behind that automatically. So, you don’t have to be an expert with a spreadsheet, they will do that for free.

Doug Hoyes:  So, it knows that if shop at ABC grocery store that’s probably food so it puts it in the food category. If I go to the gas station that’s probably gas for the car, it puts it in that category. Maybe I bought a chocolate bar at the gas station so it may not be 100% accurate but it’s pretty close.

David Trahair:  Exactly. And when you start to use it, it will do the best it can but you can override and say oh you got the wrong category, switch it to the correct category, add a new category if they don’t have one existing for your needs. And in many cases there will be or in some cases some uncategorized, they don’t know what to do with it. You’ve got to go in there and proactively tell it what to do. But after a period of months, it gets much better at automatically allocating to the correct account.

Doug Hoyes:  ‘Cause it figures it out.

David Trahair:  Yeah.

Doug Hoyes:  I’m a big believer in doing whatever works for you. So, you’re right, you and I are both chartered accountants, we’re now called CPAs and so we’re numbers guys, spreadsheets, yeah sure we’ve all got spreadsheets on our computer, I bet we both have them on our phones and everywhere else. And so if you are like that then great, spreadsheets, using these online tools whatever. But if you’re the kind of person who hates spreadsheets or maybe even hates numbers or you’re really freaked out about this whole security thing, wait a minute they’re going to take my banking information and put it in the Cloud.

Okay, that may very well be a valid concern. Well, there’s always a piece of paper and a pencil, and you can write down everything you spent this month and you won’t have five years of history perhaps, you might not have the fancy coloured graphs, but that’s better than nothing.

David Trahair:  Exactly yeah. Just do it for one month, one month. It wouldn’t take you that long and I bet you it’s probably the best investment you can make it life when it comes to personal finances. Just spend the time to go through your spending for one month. People, and I’m not a psychologist but I find people are amazingly consistent. So, once you track for years you’ll see your spending is very consistent year to year. So, a month is obviously not a great sample but for many people it’s golden information if they take the time to do it.

Doug Hoyes:  Well, that’s certainly better than nothing.

David Trahair:  For sure, for sure.

Doug Hoyes:  So, that’s a starting point. Now every financial planner in the world will tell you we don’t save enough for our retirement, we got to save more, we got to save more. Is that true? If so, why don’t we save enough or is it more of a timing thing? Do we need to be starting earlier? What’s really happening with our retirement savings?

David Trahair:  Well, again it’s an individual thing. But, you know, some in the investment industry, the people who are more salespeople than professionals will try and convince people that yeah, you’re going to need millions, which is ridiculous. Most people are going to get nowhere near a million or more saved for retirement. And the problem is a lot of them just simply give up and say oh this is hopeless, I’m never going to get to that level and I just quit. So, they stop thinking about finances they continue spending more than they make, they run up credit card debt etc. etc.

What I’m saying is that if you are prudent with your money and essentially that’s as simple as spending less than you make and not running up debt so there is something to save for retirement. Factor in what you’re spending is, look at what you and your spouse, if you have a spouse, is going to get from CPP and Old Age Security and then look at the difference between your estimated spending adjusted for inflation and what the government pension plans are going to pay you. And then good news for many people is that differential is not that huge, so it’s not a million, it’s something much more attainable.

Doug Hoyes:  Now what if I’m sitting here going okay that all sounds good, I get what you’re saying. You know, when I retire I’ll be eligible for CPP and OAS depending on what my situation is at the time and the older I am now, the closer I am to that finish line. But what if I’m 30 or 40 years and I expect that I’m going to work till I’m 70 ’cause I really like it or I want to or whatever and I’m worried that by the time I get there, there will be no CPP. The government will have blown up and, maybe not blown up, that’s probably the wrong way to say it but maybe the money just won’t be there. There will be so many retired people and they will have sucked the system dry, there won’t be anything there. Do I need to worry about that?

David Trahair:  I wouldn’t. Personally I’m not worried about the Canada Pension Plan and I spent a lot of time studying what’s in there. The Canada Pension Plan was in trouble in the mid 90s. It was projected that the surplus was going to run out by I think 2015. So, the governments, the federal and provincial governments got together and made changes including increasing the contribution rate, it’s now 4.95% up to the yearly maximum pensionable earnings.

And they brought in the CPP IB, the Canada Pension Plan Investment Board, a separate arm’s length organization to handle the surplus. The surplus currently is something like 280 plus billion dollars on hand. Canada’s chief actuary studies the CPP Plan every three years and determines that it’s fully funded for at least the next 70 years, taking into account that we have an aging population. Right now more money comes in than goes out to current CPP recipients. So, the federal government is handing more money to the CPP IB every year and they are investing, and investing it well and making a good rate of return. So, personally I wouldn’t worry about the CPP not being there.

Doug Hoyes:  So, the real decision though is how much am I going to need over and above what will be there from things like CPP, OAS or if I’m one of the lucky ones who have a company pension plan, how much over and above that I will need and that’s where it all comes back to tracking your spending now so that you can then take a guess projection as to what the future will hold.

David Trahair:  That’s right.

Doug Hoyes:  Okay now I understand all that, let’s get to the meat. This show is called Debt Free in 30 so I like to talk about debt. Fortunately in your book, which as I said at the start The Procrastinator’s Guide to Retirement: How You can Retire in 10 Year or Less. In chapter two, so right at the beginning of the book you’ve got a section called Attack Credit Card Debt First. Why?

David Trahair:  Well, I think that’s a huge problem in Canada. And I’ve been looking for statistics and I found one from the Canadian Banker’s Association. This was as of December 2014 that said 60% of Canadians pay off their credit cards each and every month and therefore don’t pay interest. That means 40% don’t. Like four in 10 Canadians are living their lives, spending more than they make, running up credit card debt during their working years.

So, what’s going to happen to these people when they retire? They’re not saving anything. If they are putting money in savings they’re effectively financing it double digit interest rates on personal debt -makes no sense whatsoever. So, that’s why I put that chapter so early because, you know, if you want to get your act together, get back on side and really crank things up with these last 10 years, these all important years, and you’ve got a huge amount of credit card debt sitting there, forget everything else. Forget retirement savings, forget TFSAs, forget RRSPs and just focus on getting out of credit card debt. I mean I probably don’t have to sell you on that.

Doug Hoyes:  Oh no, I’m with you on that and I agree, credit card debt is I mean other than a payday loan, it is the highest interest rate debt that pretty much anyone can ever have. So, a lot higher than a mortgage, a lot higher than a bank loan, a car loan and so on. And there’s not a whole lot of point in my view, you can tell me your opinion in this, in saving for retirement if I’ve got $20,000 owing on credit cards and I’m paying 19% interest every month. So, saying okay I’m going to save $200 a month towards my retirement in a TFSA or an RRSP where I’m going to earn one or two or three percent when I’m paying 20% after tax on a credit card, it makes no sense to me. Does it equally baffle you?

David Trahair:  100%. I remember there was a series of articles in a recent newspaper about what people were doing in their TFSAs and there were people, you know, investing in a tax free savings account that had credit card debt with a 20% interest rate. That’s ridiculous financially. As you said they probably only make a few percent in the tax free savings account. They’re losing a ton of money because they could have used that money that went to the TFSA to pay down that credit card debt.

Doug Hoyes:  But the experts say, and you kind of alluded to it earlier, it’s a habit. If you get into the savings habit early and start putting that money aside early, even though you still got that debt you get into the habit of saving so that once your debt’s paid off you can continue on with that habit.

David Trahair:  Well, you know, well use that habit to pay off the debt rather than save – have that monthly amount go to pay off the debt.

Doug Hoyes:  And like you said, you’re not a psychologist and neither am I, though obviously we’re playing one on the radio today. To me forget about the psychology, look at the math. You’re paying 20% after tax on your credit card and you’re earning, you know, 1% pre-tax.

David Trahair:  It’s a no brainer, forget it.

Doug Hoyes:  Yeah, there really is no sense to it.

David Trahair:  Which brings up the other thing Doug, if somebody did take the time to track their finances and saw the incredible amount of interest that they’re wasting, maybe that will trigger them to change their habits, which is what really is required. We can get into alternatives like balance transfer offers to a lower interest rate, debt consolidation loans, but those strategies are useless unless the people change their habits so that they start focusing on where they’re wasting money and get back on side.

You know a balance transfer at 0% for a year sounds great and is good for a year, but if they don’t change their habits so that they could pay off the debt, then the new credit card company’s going to be one that starts charging them 20% or more.

Doug Hoyes:  Yeah, you haven’t made any progress.

David Trahair:  No.

Doug Hoyes:  And I know in my work that the largest age group, the most growth in bankruptcies and consumer proposals is the seniors, people over the age of 60 because they are coming into retirement with debt. So, I agree with you, your number one goal has to be to reduce that debt and, you know, sadly for some people they have to do a proposal or a bankruptcy while they’re in their 40s or 50s so that by the time they get to the retirement age the debt has all been cleaned up. But at a more basic level you’re saying track your spending, see where it’s going. And once you see how much you’re spending on interest that may make the decision for you a lot easier, that that’s an area you’ve got to attack right away.

Okay, this is show number 90, last week was show number 89, I did that math in my head, my guest was Hilliard MacBeth, how wrote a book called When the Bubble Bursts, Surviving The Canadian Real Estate Crash. And he obviously, based on the title of that book, thinks real estate prices are headed down and obviously he’s been correct in places like Calgary and Edmonton so far. I mean we’re recording this in the spring of 2016, the bubble hasn’t quite burst in Toronto yet, maybe it never will.

What are your thoughts on real estate? Is it as simple as saying look I don’t need to worry about retirement, I don’t need to do all this savings stuff because I own a house. By the time I retire, the mortgage will be paid off, life will be good so don’t bother me with all this saving stuff and tracking, spending and everything. I’ve got a house, that’s my retirement.

David Trahair:  I totally disagree with that. I think looking at the value of your house in a net worth statement might make you feel good, but it’s not cash. You can’t take $10,000 out of your house to spend, it’s just a paper figure that could increase, that could look good on paper, but could decrease significantly like it has in Calgary as you mentioned.

The problem with a house is there’s so many cash expenses related to maintaining a house, even if you paid off the mortgage there’s property taxes, maintenance, insurance, utilities and that’s going to go on all the way through retirement, even as I say if you’ve managed to pay off the mortgage. So, a house looks good on paper, is a good asset, but really to use it for your retirement, you have to do something with it like sell it, downsize, move to a smaller town, possibly take out a home equity line of credit or as a last case maybe a reverse mortgage if there’s no other option. So, yes a good asset but really it’s cash flow that people need to focus on in retirement, not what their balance sheet looks like.

Doug Hoyes:  Yeah, a house is a place to live, think of it like that. Don’t start worrying about is it an investment, is it going to go up? ‘Cause you’re right, if I retired tomorrow and if my house is paid off, then that’s great but you’re right, I still got to pay the property taxes, everything else. It doesn’t change. I assume you are not a big fan of carrying a mortgage into retirement.

David Trahair:  No, you know, and this used to be the case. Previous generations, nobody that would be unheard of to into retirement with a mortgage. But I’m sure you see this all the time, it’s like second nature now. Nobody is really that concerned about paying off the mortgage before retirement. They’re going into retirement with big mortgages. You know, interest rates ultra low right now, it looks like we’re in a low interest rate environment for the foreseeable future, maybe not a huge risk but if interest rates increase significantly, those people are in a really tough situation because again, focus back on the cash flow, mortgage payments would increase significantly if interest rates increased, not to mention what the housing market’s going to do.

Doug Hoyes:  Which we don’t know, we can’t see the future. But I guess that’s a good way to end the segment because it comes back again to your point about tracking your spending. If I understand how much I’m spending on the mortgage and on property taxes, repairs in maintenance, repairs the house is going to need in the future.

David Trahair:  Utilities.

Doug Hoyes:  Utilities, all those kinds of things, insurance. Then all of a sudden oh okay, maybe the house price will continue to go up by one or two percent a year, but with all those other expenses, it’s not an investment, it’s a place to live.

David Trahair:  Exactly. It’s a cash pig, that’s what it is.

Doug Hoyes:  Well, that’s an excellent way to end it. We’re going to take a quick break and then come back and talk about some practical considerations leading into retirement. My guest today is David Trehair, the author of The Procrastinator’s Guide to Retirement: How You Can Retire in 10 Years or Less and we’ll be back here on Debt Free in 30.

It’s time for the Let’s Get Started segment here on Debt Free in 30. This is the segment where we focus on practical advice. My guest today is David Trahair, the author of a new book called The Procrastinator’s Guide to Retirement: How You Can Retire in 10 Years or Less. So, David we touched on some of your advice in the first segment but let’s start from the beginning, what’s your advice for someone who is not yet retired but they have debt, where should they be starting?

David Trahair:  Well, again as I said in the first part it has to start with tracking their finances to know where they are. And this means looking at where their cash is going out. Hopefully they’ll focus on this incredible amount of interest on that debt and that will inspire them to focus on paying off that debt. Because you can’t really save for retirement when you’re already in the hole with debt, debt has to be the number one priority.

Doug Hoyes:  So that’s fairly simple and straight forward. The title of the book The Procrastinator’s Guide to Retirement: How You Can Retire in 10 Years or Less so, let’s say that the people who are listening to us are in that time frame, 10 years or less to retirement. What are some of the other practical things they should be thinking about over and above paying off debt before they get to retirement?

David Trahair:  I think the other thing they should be looking at is where their money should be going to focus on the discretionary expenses, the things that they’re spending a lot of money on like meals out, clothing, possibly cash withdrawals. A lot of people are spending a lot of money on cash withdrawals because the whole focus is with 10 years or less to go you’ve really got to get your act together. And that means freeing up money so that you can plow that into your retirement savings and the strategy essentially asks people to re-invest any tax refund from the RRSP to effectively turbo charge it.

But the key is you don’t have 40 years, you only have 10 years or less. You’ve got to put as much as possible in your retirement savings and this is the way to do it, to focus on where that money is. Some of this is luck, and again if you track your finances say you have children in university and you’re spending, your financing a lot of that, the year that your child graduates from university is a significant improvement for many people. Money that used to be going to the university can now be plowed into your retirement savings. And my worry is that people won’t think about that because they don’t track and when they have excess money they’ll just blow it, they’ll just spend it.

Doug Hoyes:  And you’ve got to be doing the opposite, you’ve got to be saving that excess money, not blowing it as you say.

David Trahair:  Right.

Doug Hoyes:  What about the concept of practicing for retirement immediately. You know, Tim Farris would call it mini retirements, the author of the Four Hour Work Week. What are your thoughts on that? So, I’m tracking my spending and I realize okay I’m spending a lot of money here or there but when I’m retired what am I going to do? I won’t be going to work. So, is retirement going to cost me money because now I’m going to have to fill in my time or is there a way to make money in retirement?

David Trahair:  Yeah, I think that’s a brilliant idea is to start thinking, start acting like you’re retired even if it’s on a part-time basis. Think about the things that you’re going to do after you’re retired, try them out now. For some people the news will be very positive from a financial point of view because they’ll find oh I enjoy parts of what I do for a living. You know, I’m going to continue to do this when I’m retired or taking up hobbies to fill their time. And obviously for those people who really have desire to say travel the world during retirement, then that’s going to have an impact on their finances. They’re going to have to have saved a lot more than somebody who’s going to work part-time during retirement.

Doug Hoyes:  So, a hobby is something to think about right now then. And again you and I are both accountants and we both work a lot. But you’ve already started thinking towards retirement. So what let’s flash forward 10, 20, 30 years, what will be some of the things that you’ll be spending your day doing, that you’ll have more time for than you’ve now that you’re working.

David Trahair:  Well, good question. Part of it is, some of what I do now I’m going to continue hopefully to continue write books, I’ll probably continue to train people on personal finance, probably on demand through the web. But my hobby is photography, so for example I’ve just bought, invested in a very good camera, I love photographing professional sports so I’m starting to do that. In fact, this summer I’ve got several weeks off just for that activity. You know, I’m already starting to that, that’s going to fill up, hopefully, a good portion of my time after I retire.

Doug Hoyes:  And what in effect you’re doing is practicing for retirement.

David Trahair:  Exactly.

Doug Hoyes:  So you may find that travelling off to that sporting event and taking pictures all day long is great or you may find you hate it, well it’s good to find that out now.

David Trahair:  That’s exactly right.

Doug Hoyes:  So, by the time you get to retirement you’ve got time to adjust and change it. And that’s a hobby that, obviously it costs some money, you’ve got to –

David Trahair:  It’s an investment upfront, yeah.

Doug Hoyes:  But there’s also I guess the potential for covering some of your costs or maybe even making some income off it as well.

David Trahair:  Possibly too. My idea is I’ve already got a website that I post the photographs is to approach an organization and say look if you give me a press pass i.e. I get in free behind the scenes, I will spend the day photographing your event and making all the pictures available for your social media to help you market your event.

Doug Hoyes:  Yeah, cover my costs and I’ll give it to you. So, there you go so from a practical point of view, track your spending so that you know what you’re spending now and you can estimate what it will be in the future. Get out of debt before you retire and then practice for retirement now. David, thanks very much for being here.

David Trahair:  Thanks for having me Doug.

Doug Hoyes:  Thanks very much. That was David Trahair. That was the Let’s Get Started segment. I’ll be back to wrap it up. You’re listening to Debt Free in 30.

Announcer:       You’re listening to Debt Free in 30. Here’s your host, Doug Hoyes.

Doug Hoyes:  Welcome back, it’s time for the 30 second recap of what we discussed today. My guest today was David Trahair, a chartered accountant and CPA, whose new book is The Procrastinator’s Guide to Retirement, How You Can Retire in 10 Years or Less. David says that rules of thumb are too general to be useful when it comes to retirement so to find out if you have enough to retire start by tracking your current spending and eliminate all debt before retirement. That’s the 30 second recap of what we discussed today.

So, what’s my take on David’s message? Well, I agree, eliminating debt before you retire is very important because when you retire, your income will likely decrease but most of your basic living expenses will remain the same. You don’t want the burden of money debt payments when you enter retirement.

So, what should you do? Well, I agree with David’s first step, start tracking your expenses now before you retire. You can use an app on your computer or if that’s too hard just write down everything you spend money on for a month and look for areas to reduce expenses or increase your income. Then use that cash flow to either pay down debt or increase your retirement savings.

If there’s no way you can pay off all of your debt before retirement, it’s time for some professional advice. At my firm Hoyes Michalos & Associates, the fastest growing segment of our business is seniors. So, we’re happy to explain how a consumer proposal may be a good strategy to eliminate debt before retirement or even after retirement, if necessary. Debt problems don’t go away on their own so the sooner you get help, the sooner you can get a fresh start and be ready for retirement.

What would you do if you received an unexpected windfall of $10,000? Would you choose to pay off debt or invest it? Today I explore these two options with Sean Cooper, a personal finance blogger famous for paying his mortgage off in just over 3 years, and my partner and co-founder of Hoyes, Michalos and Associates, Ted Michalos.

First, I asked Sean what he would recommend to someone in that situation. He noted that while you might come out ahead with investing 90% of the time, there is an undeniable good feeling associated with paying down your debt. He also mentioned:

“… if you have credit card debt, of course that would definitely make sense to pay that down rather than invest. Because with credit card debt being 19% or higher, with some retail credit cards having almost 29%, 30% interest rates, you should definitely pay that down sooner”

Sean also added that the motivation for paying down his mortgage was risk management, so he didn’t have to worry about losing his house if he were to lose his job.

Pay off debt or invest? Depends on the return and the risk

For Ted Michalos, the decision to invest was dependent on two factors: the tax rate and risk.

Let’s say you have a mortgage with 3% interest, your marginal tax bracket is 25%, and an investment would return 4%. In this case, income tax would reduce the amount the investment would return to 3%. So now both are equivalent financially speaking.

Even if the investment would earn a little more, there are risk factors to consider. You could lose your investment depending on where it is invested. However Ted points out there is risk with your debt as well. Let’s assume you have a mortgage. Interest rates could rise, your home value could drop in value or you could get laid off and not make payments. Putting money towards your debt provides security against any of these possibilities.

Ted adds:

“The lower the amount of money we’re talking about, the more inclined I am to say that it’s not worth any kind of risk, your safer rate of return is to pay down the debt.”

When would I consider not paying my debt?

There are many kinds of debt – mortgage debt, car loans, credit cards. What you choose to do may depend on the type of loan you carry.

If you have a low interest car loan and no other unsecured debt or mortgage, it may be better to place the money in a TFSA so that it is available for an emergency. In addition, the car loan is listed on your credit report. If you pay it off completely, it may lower your credit score.

“It’s a horrible trap that people can fall into. You think you did the best thing possible by paying off all your debt, but if you don’t have debt, if you’re not using credit, then they don’t score you as high as somebody who regularly uses credit and makes all the required payments. So, if there’s no history there, if they can’t look to see you owe this money and you make your payments every month, you don’t rate as highly as somebody that does. It doesn’t make a lot of sense.”

When would I consider paying my debts?

If you are carrying debt on a high interest credit card with 15% -22% interest or on a store credit card with 29-30%, you will have a better rate of return putting the $10,000 towards your debt than you would investing it at a 4% rate of return.

Even with option of putting $10,000 into an RRSP and receiving $2,500 in a tax refund overall the math doesn’t work for many reasons:

• the tax refund comes several months later and you are paying interest in the meantime
• the refund likely doesn’t cover the full interest costs on credit card debt for a year
• you only get a tax break once, the credit card debt remains until it’s paid in full

And that doesn’t take into consideration the penalties you pay if you try to take out money from your RRSP. RRSPs defer taxes, but they do not eliminate them. If you’re in the 20% tax bracket and you defer 20% of the tax on the money you put into your RRSP today, you may have to pay more tax if you are in a higher tax bracket when your withdraw from your RRSP, 30 years from now.

Instead, Ted suggests paying down your debt and using the amount you saved in interest to invest into a RRSP. For instance, if you have a credit card with 20% interest and you put your $10,000 on your credit card, you’d save $180 a month interest. If you invest that $180 monthly into a RRSP, you would have over $2000 invested after a year. That would give you a tax refund of $500.

Ultimately it depends on math and risk

In the case of high interest credit card debt running the numbers can show that paying down debt makes the most sense. With other debts, ask yourself how much risk you can tolerate. Paying off debt is a guaranteed return. You reduce your risk to unforeseen events and likely will sleep better at night.

Listen for more insight in the podcast or read the transcript here below.

Resources mentioned in today’s show

• Sean Cooper Blog
• Tangerine – Sean Cooper Author
• Million Dollar Journey – Sean Cooper
• @BurnYrMortgage
• How To Pay Off Your Mortgage Faster with Sean Cooper

FULL TRANSCRIPT show #88 with Sean Cooper and Ted Michalos

To start today’s show I want to ask you a question. Let’s call it a thought experiment. Let’s assume that you have some debt, it might be credit cards or a bank loan or a mortgage on your house. Now let’s assume that you just received an unexpected windfall of $10,000, that’s money you weren’t expecting but here it is. Let’s assume it was an unexpected inheritance. What would you do with the money? Would you pay down debt or would you invest it?

That’s the question on today’s Debt Free in 30 show. Is it better to invest or pay down debt? Now, obviously the answer will depend on the type of debt you have and how much you can earn on your investments. Let’s start with a simple example. Should you pay down your mortgage or use the money to invest? That’s a question I asked Sean Cooper, here’s the clip from that conversation.

I’m joined now by Sean Cooper who is a personal finance blogger and writer and he’s also the guy who paid off his mortgage really quickly. So, Sean, you are faced with a decision, do I pay off my mortgage really quickly or, because interests rates have been low for the last few years, should I instead pay my mortgage more slowly and use that money to invest? And you bought your house I guess, it was 2012 when you bought it?

Sean Cooper: That’s correct.

Doug Hoyes: And paid the mortgage off in 2015. So, that was during a period when interest rates were low and the stock market was doing well. Somebody listening to this podcast, if they’re listening to on iTunes or on their phone maybe listening to it at some point in 2016 or 2017 when the world is different perhaps, by the time they listen to this podcast interest rates have gone up or the stock market has gone down. But during the period when you were paying down your mortgage, you focused on paying down the mortgage, not in investing. So, why did you make that decision and what do you think other people should be doing in a similar situation?

Sean Cooper: Well, that’s an excellent question Doug. I would definitely say that investing versus debt repayment; it’s definitely a personal choice. If you run the numbers, investing might come out ahead probably 90% of the time. But in terms of paying off debt, there’s a good feeling that you get from getting rid of debt, whether it’s paying off your mortgage or getting rid of debt from your line of credit or credit card debt if you have it.

So, it can definitely – basically take a look at like, first of all, it depends on the form of debt that you have. Now if you have a mortgage, mortgages traditionally have low interest rates, but if you have credit card debt, of course that would definitely make sense to pay that down rather than invest. Because with credit card debt being 19% or higher, with some retail credit cards having almost 29, 30% interest rates, you should definitely pay that down sooner if you have any sort of debt like that.

So, for me I saw paying down my mortgage as risk management because as I mentioned you can’t really depend on having a job for life anymore in this economy. So, if you end up losing your job you have a choice of – like you can stop investing but you don’t have a choice of paying your mortgage. If you stop paying your mortgage then the bank’s going to take your house away from you pretty quickly. So, basically for me it was about risk management and not having six figures of debt hanging over my head for the next 25 years. I didn’t want to have that fear of losing my house because it almost happened to my mother back during the .com bubble.

Doug Hoyes: So, for you it’s not just a mathematical question. It’s not as simple saying okay well my mortgage interest rate is 3% if I buy that mutual fund I might be able to make 4% therefore I guess I should put the money into the mutual fund. You’re looking at it much more from a psychological point of view, a stress point of view. I want to keep my stress level down and my stress level will be the lowest if I pay off the mortgage. Because then I don’t have the debt, I don’t have to worry about losing my house, losing my job, it really becomes a risk management and stress thing as opposed to a math thing, is that what you’re saying?

Sean Cooper: Exactly. And I see, a lot of people think, you know, why pay down your mortgage when interest rates are so low? And that’s definitely a great point but for me I see interest rates being low as an opportunity rather than to basically pay down debt. Because when interest rates are low, debt is a lot cheaper so you can pay down your mortgage a lot quicker. When your mortgage renews if interest rates are 2% higher, then it’s going to take you a lot longer to pay down your mortgage. So, I basically say, you know, make hay while the sun shines and pay down your mortgage when rates are low. Because I don’t think mortgage rates are going to be this low forever. So, definitely take advantage of the low mortgage rates we have today.

Doug Hoyes: Excellent. Well, that’s great advice, thanks very much Sean.

Sean Cooper: Thank you, my pleasure.

Doug Hoyes: So, Sean made some interesting points. He said that even ignoring the numbers, there’s a good feeling you get from getting rid of debt. So, even if the math may make it appear that investing is a better financial option, paying off debt may make you feel better. He also said that in this economy, if things go bad you can stop investing but you can’t stop paying your mortgage so having debt is risky. Sean also makes the point that the type of debt is important.

So let’s explore that topic further and to do that I’m joined by my Hoyes Michalos partner and co-founder Ted Michalos. So, Ted, what are your thoughts, if one of our listeners just got a lump sum of money, should they pay down debt or consider investing it for higher returns? And to make the question a little more specific let’s assume that the only debt we’re talking about first is a mortgage and I don’t know let’s say the interest rate is 3% and the person thinks they can earn 4% on an investment. So, is the answer to that question obvious?

Ted Michalos: Well, let’s take a second and make sure that everyone understands what interest is. So, it’s a term that is used a lot and everyone knows there’s a number associated with it. But the way to think about interest is it’s what somebody pays to use someone else’s money. So, if you are investing your money, somebody is paying you to let them use their money when you are borrowing from someone, you’re using their money and you’re paying them interest.

So, interest is the key to all of this. And so, we got $10,000 and we got a mortgage at 3%. Or we think we can get 4% on an investment return. That’s an interesting discussion. So, you’re making more money than you’re actually paying, so a quick answer would be okay make the investment. I’m not sure that’s the right answer ’cause it gets a little more complicated ’cause you’ve got to look at things like tax rates and that amount of risk that 4% investment has and now you’re back into the points that Sean was making. Are you better off paying down debt? I think the smaller the windfall, the easier the answer’s going to be for me. So, $10,000, I’m almost always going to advise that you pay down debt. $100,000 now wait a minute now this gets a lot more complicated.

Doug Hoyes: Well, so you hit on a couple of points there. So, tax rates.

Ted Michalos: Yeah, we could spend a lot of time talking about taxes.

Doug Hoyes: Which we won’t because we’ll just all go crazy and everybody will tune out. But one of the factors that you’ve got to consider in this discussion is the taxes. So, if I have a mortgage, I’ve got $10,000 in my pocket and I can put that money into an investment, the 4% I’m earning on the investment, I have to pay taxes on but the 3% on my mortgage that’s already existed, I’m, I mean that mortgage was there even before I got the investment, that’s not a tax deductible expense.

Ted Michalos: And you’re paying the mortgage in after tax dollars.

Doug Hoyes: So, in that example it’s not a good investment because I don’t know, let’s assume I’m in the 50% marginal tax bracket.

Ted Michalos: Let’s say 25%, you’re an average working person.

Doug Hoyes: Yeah, so my 4% that I’m earning is really only 3%. And I’m paying 3% on the mortgage well I’m no farther ahead then. If my tax –

Ted Michalos: In fact I would argue that you’re behind because you’ve taken the risk of losing your $10,000.

Doug Hoyes: And that’s the other component to it, so now you think well, what’s the risk in having a mortgage?

Ted Michalos: Well, interest rates could go up, the value of your property could go down or you could get laid off and not make the payments.

Doug Hoyes: So, there’s a few key points there. Interest rates could go up and we’re recording this in the spring of 2016 when interest rates are still low. If you happen to be listening to this broadcast, two years in the future, maybe interest rates are a lot higher. We certainly saw in the oil patch back in 2015 and certainly into 2016, house prices can go down.

Ted Michalos: They can. Every day in the papers right now they’re talking about the price of detached homes in Vancouver and Toronto. People are trying to figure out: are they overvalued? And we can have a whole show on that but we’re not going to get into that today.

Doug Hoyes: No but I will have some guests in the future who are going to talk about that as well. And I guess we’ll only if things are overvalued five or 10 years in the future when we look back. If I can buy a house that’s grossly overvalued for a million dollars today but I can sell it for a million and half next year, well I guess it’s even more grossly overvalued.

But the point you’re making and the point Sean made, is about risk. If I’m earning 1% on my investment over what I’m paying on my mortgage and my house goes down by 10% I’m wiped out, it was a ridiculous idea. And in Calgary house prices and Fort McMurray and places like that, they’ve gone down by more than 10%. So, it’s a very scary thing. So, do you think it’s a math question or is it more of a risk question, as to whether I should be investing or paying down debt?

Ted Michalos: Well, again down I’m back to the if it’s $10,000, my answer’s going to be one way, if it’s a much larger number, an inheritance or lottery win, my answer could be significantly different. So, the lower the amount of money we’re talking about, the more inclined I am to say that it’s not worth any kind of risk, your safer rate of return is to pay down the debt.

Doug Hoyes: So, your point is if I’m risking $5,000 oh well, if I get wiped out that’s not the end of the world. If I’m risking $100,000 then it’s a different story. And when we talk about risk, and again we’re talking specifically about mortgages here, the risks are that the house price could go down, the risk is that the investment I put my money in instead of paying down the mortgage could not go up or could go down. And then I guess the third risk is you; you could lose your job.

Ted Michalos: Yeah, you could get sick, something could happen. Or, you know what? Something unplanned for comes up that you needed the money for. Well, I guess if you had the investment you could cash it out and then use the money for that. If you’ve paid down the debt, I suppose the answer would be you increase the debt again to have access.

Doug Hoyes: But either of those things are not as simple as they would sound. So, I’ve got this investment, well is it some stock on the stock exchange that I can sell tomorrow and get my money or is it a five year locked in GIC? Is it an investment in a small business that can’t be liquidated? And you would think, okay I paid down my mortgage by $10,000 I can just go back to the bank and bump it up.

Ted Michalos: Maybe.

Doug Hoyes: Maybe. What would cause the bank to say no to that?

Ted Michalos: Well, if the – if you’ve paid down the mortgage and the situation has changed, so that the value of the home maybe has dropped or hasn’t increased the way they wanted or your personal situation as far as income or health, that sort of thing has changed, you may not be a good risk to the bank anymore. Or they may be quite happy that you paid down the debt and don’t want to give you more.

Doug Hoyes: It also depends on the form of your mortgage, so if you’ve got a conventional mortgage where it’s got five years more to run, you’re paying a certain amount every month, the bank can’t be just increasing it and decreasing it every week. If you have a secured line of credit, well okay I guess that’s a bit of a different story. And I guess there’s pros and cons on both of those. The advantage on the line of credit, secured by your house is that you can pay it off whenever you want.

Ted Michalos: You can. A line of credit secured on your house though, is usually a higher interest rate than a mortgage.

Doug Hoyes: And there’s more temptation with it too.

Ted Michalos: Correct. I mean the reason banks were granting lines of credit against houses a few years ago, and they don’t do much of it anymore, was they wanted you locked into borrowing from them. So, if I’ve given you a $50,000 line of credit on your house, well hopefully you’ll spend that $50,000 so they’re making interest on it, as opposed to applying for a new credit card from somebody else or diversifying. They’ve got all of their eggs in one basket, you being the basket.

Doug Hoyes: And it’s not – to register a mortgage actually takes some time too.

Ted Michalos: Yep and there are costs involved. So, I mean banks may ask you when you go into register a mortgage; well do you want us to register extra? I know this sounds stupid, but it’s so then they can put a secured line of credit or something on the house later. Lots of people now are being asked to simply sign a carte blanche security agreement saying you’ve got a mortgage with the bank, a line of credit, credit card and overdraft, you sign a security agreement that says all of these things are pledged against your house. Those are hugely dangerous but that’s another show we can talk about.

Doug Hoyes: Yeah. And so what we’re getting into here is the area of risk. So, when you’re thinking about should I pay down my mortgage or should I invest the money, the two key considerations then I guess are the math.

Ted Michalos: Yep.

Doug Hoyes: And the second one is the risk.

Ted Michalos: That’s right.

Doug Hoyes: Those are really the two. So, okay we’ve talked about mortgages and I think that is a relatively simple question to answer. I mean okay, 3%, 4%, you can kind of do the math. But what if we get into different types of debt, so let’s go up the secured ladder and look at things like car loans. So, a car loan maybe one of those, you know, no interest for five year deals. So, does it really matter if you pay that off or not?

Ted Michalos: It would be less of a concern to pay that type of debt down if they’re not charging you any interest. Remember what I said, interest is the price you pay for using somebody else’s money. It’s a question then of, is the car depreciating faster than you’re paying down the debt. So, it gets a little complicated but if you’ve got a five year car loan, for the first two and a half years you owe more money than the car’s worth. Because the car’s decreased in value faster than you’re paying down the debt. After that, somewhere around your two and half, maybe month 36, the car should be worth more than what you still owe.

So, one school of thought would be if you get this lump sum of money, pay down that car loan even though it’s at no interest to get it to the point where the car’s worth more than what you owe against it.

Doug Hoyes: And that’s the math answer, and I totally agree with that. You drive a car off the lot, a brand new car it’s worth $10,000 less or whatever it is right the day you do it. What about the whole concept of flexibility then. If I have a loan against a car, I can’t just sell the car I’ve got to make sure I sell it, get the bank to sign off, get enough money to cover the loan. If I’ve paid off the loan, sell the car whenever I want, put it on Kijjiji, put in on Auto Trader, boom it’s gone, I have no other worries.

Ted Michalos: It still isn’t quick though.

Doug Hoyes: No, but at least that would be an argument I guess in favour of paying down the car loan even if it’s a lower interest loan.

Ted Michalos: Yeah, I think if all you had was this low interest car loan and no other unsecured debt or mortgage or something and you suddenly came into $10,000, I might be more inclined then to put that in a savings account or some kind of investment vehicle just so you have it for a rainy day. But that might just be me as a conservative accountant. Like that may not be typical advice you give somebody.

Doug Hoyes: Well and which raises the point then that you as the individual consumer have to look at your own risk profile. I may say to myself yeah I don’t mind having that car loan at 0 interest ’cause it’s really costing me nothing. And having that $10,000 sitting in a savings account or a TFSA or something I can access quickly, gives me a lot of comfort ’cause I know if for some reason I have trouble paying my rent one month, there’s a bunch of money sitting there. If my car breaks down and I need a new engine well the money’s sitting there. So, the risk minimization I guess is a big factor.

One factor we didn’t hit on in that scenario, is your credit report. So, if you pay off your car loan completely and now have no debt, in this mythical scenario that we’re painting, and I suspect most people that have a car loan probably have a mortgage or credit cards or something else.

Ted Michalos: I know I do.

Doug Hoyes: There you go. If we paid off that debt and you had no more debt on your credit report that may potentially even lower your credit score. You have no debt anymore.

Ted Michalos: It’s a horrible trap that people can fall into. You think you did the best thing possible by paying off all your debt, but if you don’t have debt, if you’re not using credit, then they don’t score you as high as somebody who regularly uses credit and makes all the required payments. So, if there’s no history there, if they can’t look to see you owe this money and you make your payments every month, you don’t rate as highly as somebody that does. It doesn’t make a lot of sense.

Doug Hoyes: It’s a bizarre show but again you can go back and listen to the show I did on credit rebuilding and how that all factors into it. But again we’re trying to figure out reasons why I would not pay down debt ’cause I think Ted, you and I are both the same. If I have a chance to pay down debt, that’s what I’m going to do. There’s less risk, I’m not paying interest, my life is simpler.

So, the default answer I think for us, is pay down debt. But there may be legitimate reasons why you wouldn’t. Keeping some active, open credit on your credit report may be one. But then again that only matters if you’re going to be borrowing again in the future. So, if I don’t plan on buying a house or a car then my credit score is much less important to me. So, I think the answer becomes really obvious when we look at the other types of unsecured debts like credit cards.

Ted M  It’s not going to take long to get into credit vehicles or tools that the interest rates are so ridiculous that paying them down only makes sense. So for instance a good credit card, a low rate credit card at a bank these days is what, 10, 11% interest? And if you start missing payments or have a problem they bump it to 15 or maybe 18. A standard credit card, you know, a TD Emerald or something, a TD Green Card is probably at 18 or 21%. And then a store card is at 28, 29, 30%. So, the higher the interest rate on this debt that you’re carrying, the easier this decision’s going to be. If you had $10,000 and you know you could make 4% return on an investment or you pay off $10,000 worth of 29% interest credit debt, well you’re making a much better rate of return on paying down the 29% debt. It’s no comparison there. You shouldn’t even think about it. Go ahead and do it.

Doug Hoyes: Yeah, it takes 10 seconds to do that analysis. 30% after tax on my department store credit card or maybe I can earn 4% on my investment. And I guess the final caution I would give on that, when you’re talking to your investment advisor and they say oh yeah, you’re going to get a 5% or 10% rate of return, well there are really no guarantees in any kind of investment.

Ted Michalos: Correct.

Doug Hoyes: So, I guess if you get a GIC at the bank that pays 2% interest.

Ted Michalos: And good luck getting one of those right now.

Doug Hoyes: Yeah, they don’t exist. But if they did then I guess as long as the bank doesn’t go bust you’re good.

Ted Michalos: You know what? This is the scenario I think that’s most likely to happen. You get this $10,000 windfall and your investment advisor says you know what? You should put that $10,000 in your RRSP ’cause you’re going to get a $2,500 tax refund. So, that’s automatically a great rate of return over the two or three or four percent you’re going to make on the investment. So, now it’s do I put down $10,000 on my RRSP or pay $10,000 worth of credit card debt. I’m still of the opinion that you pay down the credit card debt.

Doug Hoyes: And that’s an issue I’d like to talk about a bit more and we can also get into TFSAs, which have some slightly different tax consequences too, so let’s talk about that in the Let’s Get Started segment.

To wrap this segment up though really what you’re looking for when you’re trying to decide should I pay down debt or should I invest, is what is the math say? ‘Cause with a credit card it’s obvious – pay down the debt and what risk am I taking by continuing to hold that debt? Would I be better off paying it off even if the math maybe doesn’t suggest it? Would I feel better by doing that? So, that’s where we’ll end this segment. We’ll be back with more. You are listening to Debt Free in 30.

It’s time for the Let’s Get started segment here on Debt Free in 30. I’ve asked Ted Michalos to stick around for this segment where we focus on practical advice. So, Ted we addressed it a bit in the previous section and one comment I hear a lot in this debate over investing or paying down debt is, you don’t really need to choose. You can do both. So, some financial advisors say that you should contribute to your RRSP and then use the tax refund to pay down your debt, that way you get the best of both worlds. So, can you walk us through the math on that and tell is whether or not that concept even makes any sense?

Ted Michalos: Well before the break we were using a $10,000 windfall as an example so let’s carry on with that. So, $10,000 into your RRSP or $10,000 on a 28% credit card or should we be fair make it a 20% credit card?

Doug Hoyes: Sure, let’s go with 20, keep the math simple.

Ted Michalos: Alright so the $10,000 on a 20% credit card, you’re paying in excess of $2,000 a year in interest only, if you don’t pay down the card. So, that’s $2,000 works out to $180 a month. So, the RRSP if we put $10,000 into it and let’s say you get a $2,500 tax refund, so you then apply that $2,500 to the debt six months later when you get your tax refund. So, it’s going to reduce your debt and the amount that you pay by $500 so you’re still out – the math doesn’t work.

Doug Hoyes: You’re right, the math just doesn’t work. And the credit card debt continues on forever or continues on until you pay it off, whereas you only get the tax break on the RRSP once when you put the money in. Obviously anything you earn in the RRSP is sheltered.

Ted Michalos: But it stays in the RRSP and if you take it out there’s a hit.

Doug Hoyes: Then you pay tax on it. And that’s a key point, an RRSP is a tax deferral mechanism, it’s not a tax reduction mechanism. It’s not something that you can save tax; it’s something that you defer tax on. So, if I’m just starting out in the work force and I’ve got a low paying job and I’m in the 20% tax bracket, well I defer 20% of the tax when I put it in. But if I withdraw the money 30 years from now when I’m in a much higher tax bracket, I’m paying more tax.

So, it’s a deferral mechanism, not a way to eliminate tax. You’re paying tax – or sorry, the money that you’re paying on your credit card is after tax dollars, so what does that mean? What do we mean when we say after tax dollars?

Ted Michalos: Well, so if you’re in that 25% tax bracket, to make a $400 payment on your credit card, you actually had to earn $500 in the first place.

Doug Hoyes: So, think about that then. So, the, you know, I had to work how many hours to make that payment is I guess the way you got to think about it.

Ted Michalos: Every hour that you work, well three quarters of the hour, you get to keep, one quarter of the hour, the government gets to keep.

Doug Hoyes: And that’s assuming you’re in a 25% tax bracket. If you’re in a higher bracket than that you can, you’re paying more. And I mean we’re just passing through tax season now as the show’s coming out. Go and look at your tax return, look at the total income line and look at the total you had to pay both in federal and provincial tax, that’s your total tax rate, that’s not your marginal tax rate, which is the tax on the last dollar you owe, or sorry, earn. And obviously that doesn’t include GST and all the other taxes you’re paying either.

Ted Michalos: I mean I want to flip this over on the investment advisor that’s telling you to do the RRSP. So, if you paid $10,000 worth of your credit card debt down at that 20% interest that we were talking about, you’ve now reduced your monthly payment by $180. If you took that $180 and put it in your RRSP, I’d have less of an argument with you.

Doug Hoyes: So, pay, so what you’re saying is pay down the debt and then use the savings to invest as opposed to the other way around.

Ted Michalos: Right, much safer ’cause the debt’s gone. You’re not paying somebody else to now use their money, they’re paying you to use your money. You won’t get anywhere near the tax refund, right? ‘Cause you’re only going to put $180 a month in that, in your RRSP so at the end of the year you’ve thrown in $2,000, your tax refund is $500, which you could then use to reward yourself for making good financial decisions.

Doug Hoyes: Yeah and I guess if you wanted to look at this as a math question well do the math, get a spreadsheet out, get a piece of paper and a pencil and map it out. So, I’ve got this money, if I pay it down on my credit card, how much interest am I therefore not going to have to pay. If I put it in a RRSP, I get a tax break but then I’m still paying interest for years and years on my credit card. The math probably is going to be pretty obvious when you do it that way.

Ted Michalos: You can’t compete with paying down credit card interest; the rates are just too high. If you’ve got credit card debt, unsecured debt of that type, pay it down, you’re always going to win.

Doug Hoyes: And we did mention in the first segment that the investment that you’re putting the money into, the RRSP investment that your investment advisor is putting you into, is most likely not guaranteed, probably not even close to guaranteed. So, just because the stock market went up 10% two years ago, doesn’t mean it’s going to go up 10% next year, it might go down 20%. It goes up and down. So, how much worse will you feel, still having credit card debt and now having an RRSP investment that’s gone down? It’s even worse. So, ultimately Ted what it comes down to is what we talked about at the first segment, math and risk.

Ted Michalos: Correct. And you know what? Say it easily, what’s going to make you feel better?

Doug Hoyes: So, yeah I think that’s a great place to default. Look at the numbers. If you are the kind of person who is risk adverse and would prefer not to have any debt out there, then the answer is real simple, real obvious, pay down the debt. If you can’t afford to do that well then maybe you do need to be looking at a proposal or a bankruptcy but again that’s something we’re always happy to talk to you about.

Ted, thanks very much for being here for the Let’s Get Started segment. That was the Let’s Get Started segment, I’ll be back to wrap it up on Debt Free in 30 right after this.

Announcer:       You’re listening to Debt Free in 30. Here’s your host Doug Hoyes.

Doug Hoyes: Welcome back, it’s time for the 30 second recap of what we discussed today. On today’s how my guests Sean Cooper and Ted Michalos answered the question is it better to pay down debt or invest. Sean believes that even for low interest rate like a mortgage paying down debt is the least risky alternative. Ted agrees and said the answer is even more clear when dealing with high interest rate debt. That’s the 30 second recap of what we discussed today.

So, what’s my take? Well, I think you should ask yourself two questions. First, what does the math say? If you’re paying 30% interest on your department store credit card and your investment may earn 4%, the math is obvious, pay off your debt.

The second question is how much risk can I tolerate? Paying off debt completely eliminates the risk that you will not be able to pay off your debt. Even if your mortgage interest rate is only 3% paying down that mortgage eliminates that debt and that interest payment. You can’t lose. As Sean Cooper said, it’s a good feeling. You don’t have to worry about getting sick or losing your job or not being able to pay your debt. You’ve reduced your risk and that makes it much easier to sleep at night. So, the obvious decision, in virtually all cases, is pay down your debt.

And as I said on the show, if you have more debt than you can handle consider a consumer proposal or even bankruptcy as a way to eliminate your debt once and for all, and completely eliminate your debt repayment risk.