Making an RRSP contribution helps you save on taxes – you may even get a tax refund. But what if you don't have enough money to make a contribution? Should you borrow? Here are some factors to consider before deciding.
4 factors to consider
1. Interest rates
What is the interest rate on the loan? Borrowing money when interest rates are high can be costly. Interest charges can add up, and offset the initial benefit of making the RRSP contribution. Also, interest on money borrowed to contribute to an RRSP is not tax-deductible.
2. Paying back the loan
Can you afford to make the loan payments on time and to pay the loan back quickly? If you can't afford to pay the loan back within a year, it probably doesn't make sense to add more to your overall debt load. If you're planning to use a tax refund to pay off the loan, you'll need to be disciplined about applying the refund to the loan.
3. Your level of debt
Do you have other high-interest debt? If you're already paying high interest on credit card debts, for example, your priority will likely be on paying down this debt as quickly as possible – and not taking on more debt.
Caution: If you don't pay off the loan as scheduled, you may end up paying more in interest than what you get back in a tax refund. Also, the interest is not tax-deductible. Learn more about borrowing to invest.
4. Your taxable income
Do you have taxable income? And if so, what tax bracket are you in? If you're in a lower tax bracket, there may be no tax advantage to making an RRSP contribution even if you have the contribution room.
2 other strategies to consider
Instead of borrowing a large amount to make an RRSP contribution, you may want to use 1 of these strategies:
Contribute what you would have paid to service the loan – For example, if you were going to borrow $20,000 and make a $350 monthly loan payment, contribute that $350 to your RRSP each month. You’ll pay no interest and you won’t be affected if interest rates rise.
Take out a series of 1-year loans instead of 1 big loan – This may make sense if you have a lot of RRSP contribution room to catch up on and you're not comfortable taking on a large amount of debt. With smaller loans, you'd pay less interest and carry less debt overall. And, you could use any RRSP refund to pay off your catch-up loan. Review your debt situation every year to make sure this approach is still working for you.
Content in this section is provided in partnership with Investor Education Fund, a non-profit organization founded and supported by the Ontario Securities Commission that provides unbiased and independent financial tools to help Canadians make better money decisions. To find out more, go to: GetSmarterAboutMoney.ca
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