Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books. tcestnick@waterstreet.ca
If there is one key difference between my wife, Carolyn, and me, it's that she's quick to ask for help if she gets lost. I'm not at all like that. I'd much rather navigate with my GPS to get me where I'm going. Heck, I'd sooner pull out a compass or navigate by the location of the sun or moon than stop to ask for directions.
I'm teaching my boys the same skills. I quizzed them recently: "What do you say when you haven't found your destination and your mother (or future wife) claims you're lost?"
"I'm not lost, I know where I'm going," they replied in unison.
"Very good," I affirmed. "And what do you say when you've been searching for a while and eventually run out of gas?"
"Look! We're here!" said my son Win.
"Absolutely. Good work, boys," I applauded.
Asking for help is not something many people – particularly men – care to do. I'm not going to argue with that approach, unless you're saving for retirement. If you find yourself short on cash to make a contribution to your registered retirement savings plan (RRSP), then getting help by borrowing can make good sense.
Borrow from yourself
Before you jump to borrow from your financial institution, consider whether you have assets inside your tax-free savings account (TFSA) that you can withdraw to contribute to your RRSP. Think of this as borrowing from your TFSA rather than the bank. You can re-contribute to your TFSA on a monthly basis just as you might make loan payments to the bank, if you have the cash to do this. You'll save yourself interest costs this way, although you'll need to be disciplined to ensure you actually replace those TFSA dollars – otherwise, you're not increasing your overall savings. This may be the biggest challenge.
Borrow from a bank
If you haven't got a TFSA or other assets to contribute to your RRSP, you're generally going to be better off borrowing from the bank to contribute than not contributing at all. You'll generally be able to take out an RRSP top-up loan at a pretty reasonable rate – usually prime (currently 3 per cent) if you're a good customer at the bank.
When borrowing, aim to pay off the loan with the tax savings (usually coming back as a refund) that you'll enjoy as a result of the RRSP deduction you'll claim. It's not hard to figure out how much to borrow so that your total RRSP deduction creates tax savings sufficient to pay off the loan.
Consider Janice. She is going to contribute $5,000 of her own money to her RRSP before the March 3 deadline this year. If she were to borrow another $3,333 to contribute before the deadline, she'd have total contributions of $8,333 which she can deduct on her 2013 tax return. Janice's marginal tax rate is 40 per cent, so she can expect tax savings (a refund) of $3,333 from her RRSP deduction – about enough to pay off the bank loan.
How did Janice figure out the amount of the loan she should take in order for her refund to pay off the loan? Here's the math: The amount borrowed should equal the amount of your own money contributed, divided by the following formula: 1/MTR – 1 (where MTR is your marginal tax rate).
Janice's marginal tax rate is 40 per cent, so the formula for her looks like this: 1 divided by 0.40 is 2.5, then subtract 1 and it will equal 1.5. Since Janice contributed $5,000 of her own money, she took $5,000 and divided it by 1.5 to arrive at $3,333, the amount of the loan.
Now, perhaps you've accumulated more than just a little RRSP contribution room. You might consider taking out a larger catch-up loan and pay it off over a longer period – say, five years. If, for example, you can afford a $300 monthly payment, you could borrow about $16,000, assuming a 4.75 per cent loan rate on a five-year loan. Over those five years, you'd pay about $2,000 in interest to the bank, but you would have deferred taxes of $6,400, assuming a marginal tax rate of 40 per cent. The value of this tax deferral will outweigh the interest costs over the long term.
Some might argue that, rather than using the $300 each month to make loan payments, you should simply contribute that $300 to your RRSP monthly and avoid the debt. Although the interest on the loan is not deductible when contributing to an RRSP, getting more money into the plan sooner with a loan should leave you better off in the long run.
Tim Cestnick