One strategy to increase the amount contributed towards an RRSP (and pay less taxes) is to take out an RRSP loan.
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RRSP loans are offered by most banks and are designed to allow a taxpayer the ability to maximize their RRSP contribution.
The idea behind the loan is that it will be short term: the taxpayer will borrow the money to contribute towards their RRSP, and then use their tax refund to help pay back the loan.
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The banks love RRSP loans because in most cases it’s a win-win: they get the interest paid on the amount borrowed as well as the fees associated with any investment the investor makes (assuming the funds are invested in the bank’s investment products). The investor wins because they get to maximize their RRSP with minimal interest costs (assuming they pay off the loan quickly).
If you had $20,000 of unused RRSP contribution room and only saved $10,000, you could borrow the remaining $10,000 to maximize your contribution. If you had a marginal tax rate of 35%, your refund would be approximately $7,000 ($20,000 x 35%). If this is done, I would recommend taking the loan out as late as possible (late February is best) and then e-filing your tax return to get your refund as quickly as possible to pay down the loan. Your refund would only cover $7,000 of the loan, but the interest savings are likely worth it.
Should I Choose an RRSP Loan?
An RRSP loan might be best for you if…
- You are in a high tax bracket – the RRSP deduction will allow you to reduce your taxable income (and ultimately pay less taxes at the higher rate)
- You are disciplined at paying back any debt – in this case it would be ideal to pay back the loan immediately after receiving the tax refund
- You have no other debt (credit cards, car payments, etc)
- You have maxed out your TFSA contribution
On the flip side, an RRSP loan may not be best for you if…..
- You have consumer debt with high interest rates. In this case it is likely more advantageous to pay that off first before contributing towards your RRSP
- You have a lower income and therefore a lower tax bracket
- You struggle to pay off debt in a reasonable amount of time. Since the RRSP loans are typically at prime, the cost of the loan would increase over time as interest gets paid – and the interest isn’t tax deductible
- You lack the self-discipline to use your tax refund to pay off the loan
Conclusion: The big banks advertise RRSP loans as a way to increase your savings. But don’t believe the hype – it’s a big money maker for them through interest and selling their investment products. Interest rates vary, so you’ll want to shop around to get the best rate possible.
Personally, I do not require a loan to maximize the RRSPs but if I did, I would consider it for sure. I would then use the tax refund to pay off the loan as soon as possible.
Remember, the longer the loan is left outstanding, the less effective this strategy becomes since the interest on the loan isn’t tax deductible. You’ll want to calculate the amount of interest paid to make sure it’s still worth it.
Would you consider an RRSP loan?
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