RRSP Loans: The Good and The Bad
If you consider yourself young, then planning for retirement may not be your biggest priority right now. However, it’s always a smart decision to start preparing for your future, sooner rather than later.
Putting away money for your RRSP can be difficult, especially if you’re dealing with household bills, credit card debt, and maybe a little bit of procrastination. If you fear you will not be able to contribute to your RRSP this coming year, then there is one other option: you can borrow money in order to keep contributing to your RRSP. This article will look at the good the bad of borrowing money for this purpose.
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RRSP Loans: The Good
Maxing out your RRSP contribution is almost never a bad idea as saving for the future and for retirement are two very important financial steps everyone needs to take. If used properly an RRSP loan can be a great financial tool that can help you achieve your retirement goals. Let’s take a look at the advantages that an RRSP loan can offer you.
You Will Pay Less Tax
As many of you know (or should), an RRSP is one of the best, tax-sheltered ways, to save for retirement. An RRSP allows your investment income to grow tax-free. Also, any contribution you put towards it is deducted directly from your income. So let’s say you earn $45,000 one year and you put away $5,000 into your RRSP, you’ll only be paying income tax on $40, 000.
Enforced Savings
Borrowing money for your RRSP is an attractive option for those who lack the discipline to save on a regular basis. A lot of people struggle to set aside savings but when a loan payment has to be made, you will likely start making the necessary budget cuts to your lifestyle in order to make that payment on time.
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Easy Terms, Low Rates
Let’s say you borrow $10,000 to contribute towards your RRSP, this will cost you $270 in interest over the course of one year (at 5%). Even considering you can’t deduct the interest on loans for RRSP contributions; this is still very reasonable considering the tax benefits that come with it. With this investment, you are likely to yield somewhere between $2300 and $4900 in tax savings, depending on your marginal tax rate of course. Add in the tax-deferred growth that comes with an RRSP along with the fact that banks often defer your first monthly payment until you get your tax refund and you’re looking at quite a smart investment.
Playing Catch-up
If you have difficulty saving enough money to put away for your RRSP then you most likely have unused contribution room in your account. Borrowing money allows you to fill up this contribution room while reaping the rewards of the tax benefits.
RRSP Loans: The Bad
While an RRSP loan can be a great option for many, it also may not be the best choice for your unique financial situation. Before making any decisions and before taking on any new debt, you need to weight both the pros and the cons.
It’s Another Form of Debt
An RRSP loan is just that, a loan. This means you’ll be taking on debt, adding another monthly payment into your budget and dealing with interest charges. If you feel as though your budget can handle this added stress, then an RRSP loan could be a good idea. If your finances are already strained, a new loan, even if there are tax benefits, could hurt your future instead of helping it.
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It Will Still Cost You
For an RRSP loan to be valuable you need to be able to qualify for a low interest rate, this means you need good credit. A high interest rate will negate any tax benefits. Furthermore, you should so be able to repay an RRSP loan within one year, any longer and again the interest you’ll be paying will negate the tax benefits.
Be Wary of the Type of Investment you Make
In order to make this investment worthwhile, it is extremely important to adequately research the investment you’ll make in your RRSP. Remember, you’re borrowing to invest. You want to avoid making high-risk investments. If you do, you may ultimately end up owing more than the total value of your investment if it declines.
No Deducting the Interest
Capital borrowed for non-registered investment income tax is deductible; yet, interest on the loan for your RRSP is not. If you have the capital to invest, put it in your RRSP, then borrow for other investment so you will still reap the rewards of the tax deduction.
Finding out whether borrowing for your RRSP is right for you can be tricky and will depend on multiple factors. At the end of the day, an RRSP loan can be a strong move for your portfolio but care should be taken when deciding whether you’re in the best position to make this kind of financial move.
