Tammy Schirle is an Associate Professor of Economics at Wilfrid Laurier University
As the RRSP contribution deadline approaches, many financial institutions are encouraging their customers to make their maximum contribution. Earlier this week, a friend of mine received advice from her financial institution to borrow $5,000 to make her RRSP contribution. She asked for my advice.
I’m not a financial planner, but I’m realistic about my friend -- she’s not good with finances. I borrowed one of the big banks’ RRSP loan calculators and did some simple calculations. Like many people in her situation, it’s hard to see how this could be good advice.
Like many baby boomers, she’s only a few years away from retirement, has no real assets, and plenty of debt. She’s relatively high risk, so she’d have to pay nearly 8 per cent interest on a $5,000 loan. If paid over four years, that’s $859 in interest.
Being close to retirement she should consider investing in the lower-risk RRSPs. Some GICs are currently offering 2.25 per cent, so I’ll assume that as a return. Over four years she would earn $465 on the RRSP. If cashed out, she’ll likely pay at least 30 per cent income tax ($139.50), for a net gain of only $325.50.
She’s lost $533.50. And I haven’t even thought about inflation, the usual discounting, or any banking fees.
Suppose she let the RRSP sit for 10 years -- then the interest earnings will also result in a reduction of her Guaranteed Income Supplement benefits (50 cents on the dollar earned). She’s still losing money.
Now this is a simple calculation -- we could assume she’d use the tax refund to pay the loan, that the RRSP return would be much higher, or that she’ll have a lower marginal tax rate upon retirement. Perhaps I’m pessimistic, but I doubt that’s realistic.
So I offer this advice to anyone considering borrowing for their RRSP (though to be clear, I am not a qualified financial adviser) -- be very realistic about your own ability to save and ask your financial institution for a variety of scenarios. Find out what they are assuming when they say it is good advice. Consider the TFSA option if your retirement income is relatively low, and think about the tax and benefit implications in retirement.
Most importantly, remember that the financial institution’s first goal is to make as much money as possible.