Borrowing money is a well-known tactic for making the maximum allowable Registered Retirement Savings Plan (RRSP) contribution. But it means taking on debt and sticking to a rigorous repayment schedule.
The question is: Is it right for you?
Driven by deadlines
The deadline to contribute to an RRSP for 2012 is fast approaching: March 1, 2013. And many people who haven’t been socking money away into their RRSP for the past year are feeling the pressure to make a contribution now, before it’s too late.
But most of us don’t have a few thousand dollars just sitting around, waiting to be put to use in a retirement savings plan. With all the demands on our money with loans, mortgages and day-to-day expenses, it may be challenge to find money for your RRSP contribution. That’s where the RRSP loan comes into play.
How it works
Financial institutions know that people often either top up their RRSP or make an annual lump-sum contribution just before the deadline, so most of them offer some kind of loan specifically tailored to RRSP contributions. These loans usually have lower interest rates than conventional loans – often no higher than prime, which is three per cent these days – if you contribute to an RRSP at the institution where you get the loan.
When you make an RRSP contribution, you effectively lower your earned income by the amount of the contribution, which lowers the income tax you owe, and may result in a tax refund.
“Optimally, you then apply that refund to the loan and eliminate it sooner rather than later,” said Chris Buttigieg, Senior Manager, Wealth Planning Strategy, at BMO in Toronto.
Make it work for you
Buttigieg says there are two common mistakes that people make when taking out an RRSP loan.
The first mistake is not being disciplined enough to pay the loan off quickly. The longer you carry the loan, the more you’ll have to pay in interest, which erodes your overall savings.
The second mistake is “not making your money work as hard as possible,” Buttigieg says.
“It would be counter productive if you took out an RRSP loan, paying an interest rate of three per cent, and you go and invest that money in a saving vehicle that’s paying one per cent,” Buttigieg says. “You want the investment returns to be higher than the borrowing costs.”
An alternative to borrowing
While borrowing for an RRSP contribution might be the right decision for some people, one smart way to avoid having to take out a loan, and pay interest on it, is to set up an automatic savings plan.
After all, if someone is diligent enough to pay off a $5,000 RRSP loan in a year, Buttigieg says, they should be able to plan ahead and invest that money every month instead.
“If you set up a continuous savings plan and you have $400 going into an investment on a monthly basis, you get that money working harder for you a lot sooner versus waiting 12 months for the RRSP deadline and putting it in as a lump sum,” Buttigieg says. “So you’re taking advantage of a couple of things: You’re getting systematic, forced savings, dollar-cost averaging and you’re saving on some interest as well at the same time.”
Figuring it out
You can use BMO RRSP Loan Calculator or talk to a BMO investment professional to figure the loan amount that is right for you and your best re-payment approach.
For more information about RRSP loans, talk to your Financial Advisor, who can advise on the best investment and borrowing vehicle to suite your individual needs.