Typically, I will not advise clients to borrow money to invest in their RRSP. Got a high income and you're confident you can keep up with the interest payments on the loan? Yeah maybe you can, but if you can't? That interest on a loan if left unpaid for an extended period of time will eat away any potential earnings in your investments. There is also the chance that the interest rate will increase during the time of your loan while the expected investment returns decrease. Canadians are already carrying record amounts of debt, so it doesn't really instill a tonne of confidence for me to recommend assuming more debt for most people. Also, the interest on the loan is not tax deductible when borrowing for your RRSP.
If you don't have enough money to contribute to your RRSP, then maybe it's time to look at your financial plan and ask yourself why? Most people would benefit from an alteration to their spending habits and prioritize saving for retirement over other things instead of trying a high risk leveraging strategy to fund it...which may or may not work. If you never find yourself with a large lump sum of cash at the end of the year to contribute to your registered savings I would recommend setting up a pre-authorized debit plan where specific dollar amounts get debited directly from your bank account on payday directly into an RRSP plan. This is one of the best ways to reduce your taxable income and start saving for retirement. Starting at smaller amounts such as $50 or $100 per paycheque and then increasing it over time is the easiest way to get started investing in an RRSP.
Now let's look at a simple, low risk strategy that Canadians can implement in their financial plan that has them borrow to accelerate and SUPERSIZE their RRSP savings! One RRSP borrowing strategy that I would definitely recommend. Exciting...isn't it?
Many Canadians receive tax refunds every year when filing their tax returns, so the idea here is to borrow money based on your expected tax refund to invest in your RRSP and then pay back the loan with your tax refund. An example would be an individual who is currently in a 38.5% tax bracket who contributes $1000/month or $12,000 over the course of the year to an RRSP would realize a $4620 tax refund ($12,000 X 38.5%). So borrowing to supersize your RRSP would be calculated this way:
($12,000 X 0.385)/(1 - 0.385)=$7512.19-amount of loan to take out for RRSP contribution
Your RRSP contribution for the year now increases from $12,000 to $19,512.19 ($12,000 + $7512.19) and your tax refund now increases from $4620 to $7512.19 ($19,512.19 X 0.385) which happens to be the exact amount of your loan you took out. Just remember to pay your loan off when you get your refund, or this will not work! You were likely going to buy something silly with that refund anyways, right? Pay yourself instead. Congrats, you've just implemented a simple and effective way to make large increases to your RRSP and accelerate your retirement savings. Feels good to use math to your advantage, doesn't it?
This strategy isn't just for someone who regularly contributes to an RRSP regularly either, as it can be used for someone who doesn't contribute during the year but is getting a tax refund for a different reason. Maybe you've over estimated your income for the year and your tax instalments were too high, maybe you've got lots of child care deductions, or maybe you're super amped up to receive your Carbon Tax Rebate and use it for your retirement savings. If you, your financial advisor, or your tax professional can calculate your tax refund before the RRSP deadline, then just take that dollar amount and put it in the first part of the equation to figure out how much you should borrow.
expected tax refund / (1 - marginal tax rate) = $ amount to borrow to contribute to RRSP
Ideally, you'll want to wait as long as possible to take out the loan and contribute to your RRSP to limit the amount of interest payments. So, first make sure you have enough RRSP contribution room, make sure you're in a proper tax bracket to utilize the RRSP, if you are then take out the loan March 1, contribute the borrowed money to RRSP March 2 (RRSP deadline this taxation year), file taxes once you've received all your tax slips ASAP, receive tax refund, and then pay back the loan. You'll only be paying interest on the loan for 1 month or 2 at the most. If you're lucky enough, you may also have the option of borrowing money from yourself and pay no interest at all if you have enough money in an emergency fund or other liquid savings account.
An easy, but powerful way to increase your retirement savings and put you on the path to financial empowerment.
Happy Saving!
-Marty Metz, CFP, CLU
*(RRSP's are not an appropriate investment vehicle for all Canadians, if you are unsure if it is right for you, please consult your financial advisor or tax professional.)
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