If you’re having trouble coming up with enough money to fill your available RRSP eligible investments contribution room this year or if you’ve got unused room from previous years, an RRSP loan may be a smart strategy.
RRSP eligible investments can provide solid tax savings along with tax-deferred, compound growth so the short-term interest costs of an RRSP loan can be outweighed by the long-term benefits. Here’s an example **:
- You’re entitled to make a maximum contribution to your RRSP eligible investments of $10,000 for the 2012 tax year but you have only $5,000 of cash on hand. So you borrow the additional $5,000 (at 7% interest) and – here’s the important part – pay it back in a year.
- If your marginal tax rate is 35%, your additional $5,000 contribution gets you an immediate tax refund of $1,750 and (at an annual return of 8%) your $5,000 top-up loan earns an additional $400 at an interest cost of $190 for the loan.
- If you leave the additional $5,000 in your RRSP eligible investments for 25 years, that top-up contribution will grow to more than $34,000 (at an average rate of 8%).
- Get a low interest rate that does not eat up your potential tax savings and investment returns.
- Repay the loan as quickly as possible – preferably one year but, in most circumstances, no longer than two years.
- Use your RRSP-related tax return to pay down your loan.
- Consider using the cashflow from a Pre-Authorized Contribution (PAC) program to fund your RRSP loan payments. Depending on the interest rates using PAC income can help you by, for example, avoiding cash crunches that might prevent loan payments.
* Statistics Canada, The Daily, Friday, December 2, 2011, http://www.statcan.gc.ca/daily-quotidien/111202/dq111202b-eng.htm
** The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values or returns on investment.
Borrowing to invest involves risk and may not be suitable in all situations. Speak to a professional Consultant to see if this strategy is suitable for you.