Should you consider an RRSP loan?

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Q. My bank is currently offering an RRSP loan for $15,000. According to their calculator, I would receive a rebate of $6,750 for that contribution. If I spread the loan over 5 years, I pay $275 a month and it will cost me $1,554 in interest (3.95%). Is this loan a good idea, and is it worth it for me?
–Jonathan

A. I must say the excitement around “RRSP season” seems to have dulled in recent years. The introduction of the Tax-Free Savings Account (TFSA) has stolen some of the RRSP’s thunder. Still, for many, contributing to a Registered Retirement Savings Plan continues to make sense. But what about RRSP loans?

RRSP loans are generally at bank prime (currently 3.95%). Most banks will lend up to $50,000 with an amortization, or repayment period, of one to 10 years. The first payment is usually deferred by 90 days so that an RRSP loan taken in February before the RRSP deadline can generate a tax refund in April you can use to pay down some of the loan.

Borrowing at prime is a good interest rate. To put that into perspective, many secured lines of credit backed by your home’s value are at prime plus 0.5%. However, banks can offer a low RRSP loan rate because those loans allow them to make money twice: on the interest they charge you, and on the fees they collect on your RRSP investments.

In your case, Jonathan, the bank’s calculator suggests you will get a 45% tax refund on your RRSP contribution. That means you are in a high tax bracket. It is important to note these calculators may not be accurate because there are lots of little tax bracket changes depending on the size of your contribution, your income and your province of residence. You may also have other tax deductions that reduce your income and marginal tax rate, and cause an RRSP deduction to be less lucrative.

RRSPs are generally a beneficial tool if you can contribute in a high-income year and withdraw in the future in a low-income year. This is because the tax refund upfront can more than compensate you for the tax payable later. Given your 45% tax rate, Jonathan, you may benefit from contributing.

Someone in a low tax bracket now is less likely to benefit from RRSP* contributions. TFSAs may be a preferable option if a low-income earner can only contribute to one of the two accounts.

If someone has debt, RRSPs become more beneficial if they have a more aggressive investment risk tolerance, or if they have low investment fees. This is because paying 18% credit card interest while earning 2.0% in a GIC may not be a good long-term strategy.

As such, a conservative investor, particularly in high-fee mutual funds and especially if they are not in a high tax bracket, could consider debt repayment over RRSP contributions. The one knock against this strategy is that Canadians may be more tempted to borrow against the home equity their debt repayment creates than to take money out of their RRSPs (a vote in favour of the psychology of RRSP contributions).

If you do take out this RRSP loan, Jonathan, the result is you have a $15,000 lump sum to invest now, and then will repay the bank $275 per month for five years. Alternatively, you could just contribute $275 per month to your RRSP for the next five years. Odds are in favour of the lump sum outperforming the dollar-cost averaging of investing monthly over the next five years. The reason is that stock markets go up about two-thirds of the time. However, if you do it once, and it happens to be right before stocks tumble, that could be unfortunate. This reinforces the benefits of regular contributions instead of a one-time, large catch-up contribution.

Taking out an RRSP loan means you are borrowing to invest. You are paying 3.95% interest to try to earn, ideally, a higher return on your investments. You are generating a tax refund today in hopes that you will pay less tax in the future on your withdrawals. The thing is, for anyone with a mortgage, by not paying down debt and instead contributing to an RRSP, you, too, are indirectly borrowing to invest.

If an RRSP loan does not impede your cash flow significantly, I think it is okay to consider it. But if you can afford the RRSP loan monthly payments going forward, why could you not contribute monthly to your RRSP in the past year? It seems that adding monthly RRSP loan payments means you could have tighter cash flow going forward that could cause you to have to take on more debt. I might, therefore, lean towards redirecting what you think you could afford on a monthly RRSP loan payment to making regular RRSP* contributions for the next year.

One exception could be if your income was extraordinarily high last year due to a bonus, asset sale or some other windfall. Otherwise, consider whether you should just start contributing more to your RRSP going forward in lieu of taking on RRSP loan payments.

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