RRSP Loans advice

[Gsxrboy]

Hello everyone,

I hope that you are excited about tax season as much as I am (sarcastic sentence). In preparation for the ever looming date of when the last day for RRSP investment date draws closer, I wanted to share a possible investment strategy for those who wish to maximize their contributions for the past year.

RRSP Loans is one possible way of starting your retirement savings in a big way or a way to top off what you have contributed for the past year. The premise is simple, go to a financial institution, apply for a RRSP Loan, invest that into your existing or new RRSP account. When you receive your tax refund, use that money to pay down your loan. Isn't that simple?
Now the explanation on how this could work for some of you and perhaps a warning that this is not a one size fits all solution.

The breakdown

Loans taken to be used for investment purposes have been done before most of us have been born. It is nothing new and depending on how you use the money, a great way to invest.
Possible issues : Taking out a loan comes with the standard risks, you can lose your job, stop working due to an injury or any other reason why you cannot work. You will be on the hook for the loan amount, just like any other loan taken out, even if your investments take a dive and you owe more than what is being made. During the first year, the interest rate may be higher than the return you may get from your investments. If your loan is 8% and your investments is only returning 5% this can be viewed as bad. This does not have to be the case, when investing into the market using RRSP's we focus on the long run and not the first year we are paying off the loan.

Strategy
The RRSP loan strategy only works if you plan to pay off the loan within the first year. Investing the tax return back into the loan speeds up the repayment period, which translates to less interest paid to the financial institution.
Ideally you may want a maximum loan for $5000, which roughly translates to about $450 a month in payments. (this depends on the interest rate charged) Usually financial institutions will give their clients favourable interest rates for RRSP loans.
Once you have the money, either invest it into an existing fund or open one with the same institution and select an investment vehicle you are comfortable with. Banks will have a list of funds for those who are risk adverse, moderate or advance investors. Pick one you understand and feel comfortable investing in. If the person helping you cannot explain what you are investing in, please ask to speak to someone else, or take your business to a different place.

The difference between an RRSP Loan and simply investing $450 a month.

The calculator used is from HSBC
https://www.rbcroyalbank.com/cgi-bin...calculator.cgi
Here is the result I received when I entered the following information:
You indicated that you would like to borrow $5,000 at 6.00% interest to invest in your RRSP, and repay the loan over 1 years, 0 months.

Expected tax refund(1) on $5,000: $ 2,000.00
Amount of tax refund to apply to loan balance(2): $ 2,000.00
Loan payment amount/frequency: $ 430.33 Monthly
Total interest cost of loan: $ 102.25
Adjusted Loan Amortization(3): 0 years 8 months
Your RRSP
Here’s how your RRSP is projected to grow, based on an estimated annual RRSP rate of return of 6.00% over the next 35 years until your retirement(3):

RRSP value at the time the loan is paid off: $ 5,198.05

The result: You have made only $96 in the first year, after the loan has been paid off. Now this is where the fun begins. If we use the simple calculation of 72, we can roughly figure out when this amount will double. 72 divided into 6% (possible investment return) = 12. So every 12 years your money will double if you do not add more money to this amount. (again just a rough number)

Let us see what will happen when we simply invest $450 a month into a mutual fund earning 6% in one year.
http://www.ingdirect.ca/en/tools/index.html#
Using ING Directs calculator I get the following result
Total amount saved including interest : $5578.76
Interest earned : 178.76

In conclusion it is obviously better to save on a monthly basis instead of taking out a loan, however, for those who wish to maximize their contribution for this year, a RRSP loan is a great way to do so, only when you pay off the loan within the year and use the tax return to pay down the investment.

If you have any questions please post it here, I will do my best to answer them, for those who try to bash this post, I will simply ignore you.

[marstec]

Good advice. My husband took out RSP loans for a couple of years in a row in the 90's. The important thing, and you mentioned it, was having the discipline to pay it off within the year. As far as I'm concerned, I'd rather pay myself than to pay the government (and you do this by contributing to your RSP).

[Thanh]

Taking a loan for RRSP and then paying it monthly is plain bad-advice.

You're better off contributing periodically during the year and reducing your taxes instantly instead of 15 months later.

[ashedfc]

Taking a loan for RRSP and then paying it monthly is plain bad-advice.

You're better off contributing periodically during the year and reducing your taxes instantly instead of 15 months later.

RRSP loan also gives you the instant contribution into the RRSP account, so you don't have to wait 15 months for tax deduction.
Monthly PAC is the best approach for future contributions, but how do you take benefit of months which are already gone. With the loan approach you payments go towards loan repayment (instead of going into RRSP account). Its more or less the same.
Interest rates as low as 3.5% (on RRSP loan), is very negligible when you compare the benefits...

[Thanh]

RRSP loan also gives you the instant contribution into the RRSP account, so you don't have to wait 15 months for tax deduction.
Monthly PAC is the best approach for future contributions, but how do you take benefit of months which are already gone. With the loan approach you payments go towards loan repayment (instead of going into RRSP account). Its more or less the same.
Interest rates as low as 3.5% (on RRSP loan), is very negligible when you compare the benefits...

Also, February brings a flood of RRSP money and in times like now where the market is high, people overexpose themselves to time-specific risks. A better approach is to spread contributions throughout the year.

[Carlotta]

RRSP loan also gives you the instant contribution into the RRSP account, so you don't have to wait 15 months for tax deduction.
Monthly PAC is the best approach for future contributions, but how do you take benefit of months which are already gone. With the loan approach you payments go towards loan repayment (instead of going into RRSP account). Its more or less the same.
Interest rates as low as 3.5% (on RRSP loan), is very negligible when you compare the benefits...

You should be able to get a 1 year RSP loan at prime which is 3%. But you are still always playing catch-up. I like just starting a regular monthly PAC so that you are taking advantage of dollar cost averaging. That way you are buying some units "on sale" while others are "full price" so to speak.
You also have to factor in your tax rate to see whether you are better to claim your RRSP contribution right now or wait and claim it later. If you are only in a 15% or 20% ATR, but you expect your income to rise substantially in the next 5 or 6 years, wait until then to claim. You can make your contribution now, but not use the deduction until a later date, when you can get more bang for your buck. And ALWAYS use your refund for something that will make you more money so that you double dip. For example, take you tax refund and add it to your TFSA account if you have room. Or use your refund to fund your child's RESP, and then get an additional 20% added from the government.

[Gsxrboy]

ummm...as weird as this sounds, I agree with Carlotta.

Everyone has made some excellent points so far. At the end of my posting, it clearly shows you are better off contributing on a monthly basis, than taking a loan. Regardless of how you contribute, it is better to start immediately than always waiting for a better job or pay.