Common Sense

When Does an RRSP Loan Make Sense?

Daniel Duval, CFP - December 1, 2001

With interest rates at their lowest point in over 40 years and the markets coming off a dismal year and a half, this may be the perfect time to consider taking out an RRSP loan to catch up on your unused contribution room.

Although the idea of borrowing to invest may sound scary, there are some circumstances when it can really pay off. For one thing, as long as the return on your investment is anywhere close to the interest rate you're paying on the loan, you'll generally come out ahead financially by taking out a loan. However, one of the biggest factors to consider when borrowing to contribute to your RRSP is the size of the resulting tax refund and what you decide to do with it.

Obviously the larger the tax refund the better, so if you're in a high tax bracket and can easily afford the loan payments, it's almost a no-brainer. The crucial thing is what you do with the refund. It's important to put it to good use. Although a vacation may sound like a good use, it's generally not the best move financially. Some great uses: Pay down high-interest debt and/or credit cards; pay down the mortgage; pay down the RRSP loan; use it to make an additional RRSP contribution; invest it to earn a better after-tax return than the interest you’re paying on the loan. These are all excellent uses for your tax refund and every one will help you get ahead financially. The best option for you depends on your own situation.

Another time an RRSP loan might make sense is if you're retiring. For example if 2001 was your last full year of employment income, you could take out a loan to use up any unused RRSP contribution room in order to generate as large a tax refund as possible on your 2001 tax return. You can then withdraw part or all of it shortly after (perhaps to pay off the loan) and pay very little tax on it since your earnings will be down considerably in 2002. This strategy can potentially save you several hundred dollars in income taxes, however the figures should be examined carefully to ensure this strategy is worth the effort.

An RRSP loan doesn’t make sense for everybody. When isn’t it beneficial? Generally, if you’re in a low tax bracket (i.e. earning less that $31,000 per year), the benefits certainly aren't as appealing for you, since the tax refund generated would be much lower than if you were in a higher tax bracket. In this case, a person should really crunch the numbers and see if: 1) They can easily afford to repay the loan; and 2) Are the financial benefits worth it, or is there something more productive I could be doing with my money?

If you've determined that an RRSP loan makes sense for you, it's now a matter of deciding who to borrow from and where to invest it. In most cases, you're restricted to investing your money in the products of the financial institution that loaned you the money. If this isn't appealing to you, there are some places that will issue an RRSP loan without the restrictions. It's just a matter of shopping around.

Just remember: Borrow only what you can afford to repay! The purpose of an RRSP loan is to get ahead financially, not burden yourself with a debt load that will strain your budget. Talk to your financial advisor to see if borrowing for your RRSP makes financial sense for your particular circumstance. Daniel Duval is a Certified Financial Planner in Hinton, AB.

back to ARTICLES

Feel free to contact us at:

Common Sense Financial Ministries
22 Menlo Cres. Sherwood Park, AB T8A 0R9
phone: (780) 467-8031 (7283) fax: (780) 464-6564

HOME / TESTIMONIES / SEMINARS / MATERIALS / ARTICLES