OTTAWA – A low interest rate and the promise of a supercharged tax refund may be the tempting lure of an RRSP loan.
If people haven’t been maximizing their RRSP contributions every year, chances are they’ve accumulated a fair bit of unused contribution room.
An RRSP loan may be one way to catch up on retirement savings, but they are not without possible pitfalls.
Jamie Golombek, managing director for tax and estate planning at CIBC, says the key is to earn an investment return on the money being borrowed that is greater than the interest being paid on the loan.
“If you are just going to invest your RRSP in a GIC which will have an interest rate lower than the rate of interest on your RRSP loan, then I would say it doesn’t make sense,” he says.
Golombek says the other equally important consideration is how fast the loan can be paid back.
“You want to try and pay it back as soon as possible,” he said. “Otherwise you get into a situation where you’re no further ahead in the game if this just increases your total debt load.”
The RRSP contribution limit for a given year is based on income from the previous year. However, unused contribution room from earlier years is carried forward and can be used in future years.
Golombek says for people who have received a large bonus or a big severance payment last year, borrowing may be a strategy that makes sense.
“If the cash isn’t available because maybe they used that bonus to pay down some debt or pay down the mortgage or something else, this would be an opportunity to be able to borrow quickly, put it in and get a large tax deduction,” he said.
Richa Hingorani, senior manager for financial planning support at Royal Bank, says people can reduce their taxable income by contributing to an RRSP.
“The higher the taxable income for the year, the more advantageous contributing into an RRSP is and by that factor, the more advantageous taking an RRSP loan would be,” she said.
However, RRSP loans aren’t for everyone.
People need to be careful when considering borrowing to invest if they already have any debt, especially if they cannot afford to pay back the money quickly.
“You don’t want to get into higher debt when you already have debt,” Golombek said.
Hingorani says even though interest rates are now low, people need to be sure they can handle payments to pay off their loans quickly.
She also recommends people use their tax refunds to help reduce the amount outstanding.
“Although the loans can be expanded up to 10 years, it is not ideal to take an RRSP loan for that length of time,” she said.