When I was young, I remember going to the bank to have my bank book updated by the teller. I would always appreciate seeing the “interest deposit” line every month. This week, our youngest son went online for the first time to view his bank account activity. There it was: an interest deposit made at the end of last month.
“Dad, the bank gave me some money,” he said.
“I know, Michael. Isn’t that great?” I replied.
“Sure, but it’s just four cents,” he said.
“Well, interest rates are very low right now,” I told him.
“So, with the amount of money I have today, it will take about 83 years before I have enough to buy a scooter.”
“That’s right, son. I tell you what. When you reach age 50 and you haven’t got enough for that scooter, I’ll give you the rest.”
The Bank of Canada’s key interest rate dropped to just 0.5 per cent last summer, so interest rates are just about rock bottom. This is bad news for those interest deposits each month, but good news for taxpayers. Consider one of these strategies today to take advantage of low interest rates while you can.
1. Borrow for RRSP contributions
It’s the time of year to think about making a contribution to your registered retirement savings plan (RRSP). The deadline for contributions that can be deducted on your 2015 tax return is Feb. 29, 2016.
If you have significant unused RRSP contribution room, it can make good sense to take out an RRSP catch-up loan to use up that room and create a sizable tax deduction.
Although you won’t be able to deduct the interest on a loan to contribute to your RRSP, interest rates are low enough today that it’s pretty cheap to get caught up on your savings. Try to pay back the RRSP loan within a year, but even a three- or five-year loan can make sense if it means a shot in the arm to your savings.
2. Refinance your bad debt
There may be two key problems with your current debt: The interest may not be deductible, and your interest rate might be too high.
Based on current interest rates, consider consolidating any high-interest borrowing (such as credit cards or non-secured loans) into one lower-rate loan.
If you can, make your interest deductible at the same time. How? If you have any cash or investments available, consider paying down your non-deductible debt with that cash or those investments (count the tax cost first), then reborrow to replace the cash or investments. As long as you use the newly borrowed money for the purpose of earning income, you’ll be able to deduct the interest.
3. Borrow to invest
Borrowing money to invest can create a tax deduction for the interest costs. This is valuable at a time when tax deductions are in short supply.
Borrowing to invest can also help you to accumulate wealth more quickly, and with interest rates so low today, the cost of using someone else’s money to grow your wealth is low. Now here’s a caveat: Borrowing to invest is not for everyone. Most importantly, you need a stable income and a long time horizon. I’ll talk more about this next time.
4. Consider employee or shareholder loans
Now is a good time to consider borrowing from your employer or your own corporation. Why? You may be able to borrow at low or no interest.
You’ll face a taxable interest benefit in this case, but that benefit today will be calculated at the very low 1 per cent prescribed rate currently in effect. And if you choose to use those borrowed funds for investment purposes, or to buy a vehicle for use in your work, you’ll be entitled to claim a deduction for the amount of the interest benefit. Speak to a tax pro about shareholder loans, because the rules are complex.
5. Make a loan to your spouse
It can make good sense to lend money to your spouse to invest if he or she is in a lower tax bracket than you. The income earned by your spouse can be taxed in his or her hands if you charge the taxman’s prescribed rate of interest on the loan – which is just 1 per cent today.
The best part is that you can lock in that rate of interest indefinitely. Your spouse should sign a promissory note as evidence of the loan, and should pay you any interest owing by Jan. 30 each year for the prior year interest charge.
Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.Report Typo/Error
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