As you know, the deadline for RRSP contributions for the previous tax year is usually March 1. That means you have time to think about your taxes and still purchase more RRSPs.
If you are a procrastinator and didn’t contribute to your RRSPs throughout the year, or you start working on your tax return and realize you are going to owe money, you may want to make a lump sum RRSP contribution ASAP.
Banks will take advantage of this urgency by advertising RRSP loans. How it is supposed to work is that:
- you borrow money with a known interest and payment plan
- make a larger RRSP contribution
- get your tax refund
- partially pay back your loan
- continue to make payments for the rest of the year or until the loan is paid off
Occasionally an RRSP loan is a decent idea, but usually there are some SIGNIFICANT downsides to this plan:
- You must have enough discipline to actually use the refund to pay back the loan. Unfortunately a lot of people get that money and use it as fun bonus money, figuring they can just pay down the loan every month as planned.
- Taking on debt can be risky. You never know what the future holds, and you or your spouse could lose your job tomorrow. Then you might need your tax refund for living expenses. And even worse, you’d still be stuck with your RRSP loan payments.
Plus, the math often doesn’t work in your favour.
The amount of money you will save when using an RRSP loan relies on three factors, only one of which is a guarantee amount.
- The difference between your tax rate when you invest the money and when you withdraw it.
We can make some assumptions, but your retirement income and the tax rates then are out of our control. If you end up having to pay more tax during retirement, then the RRSP was pointless, from a pure math standpoint.
- The rate of return you will earn on your investment.
Only GICs give you a guaranteed investment return, and the rate on an RRSP loan is going to be higher than on a GIC so this is something you are unlikely to ever do.
- The interest rate on the loan. This factor at least is known, as RRSP loans are typically at a fixed interest rate.
So this strategy can be beneficial to you IF:
- You earn more on your investment than you pay for your loan, AND
- You tax rate at retirement is the same or less as you are paying now
Instead, a much better strategy is to make automatic monthly or biweekly deposits into your RRSP account. Then you are earning every month, instead of paying the bank every month.
What’s your opinion on RRSP loans?