How to use an RRSP loan to maximize your contributions

With files from Craig Sebastiano

RRSP season is usually the time of the year when you seriously think about saving for retirement. If you want to put some money away but don’t have the means to do so, you may want to consider getting an RRSP loan.

What is an RRSP loan?

An RRSP loan is a type of personal loan that lets you borrow money in order to contribute to an RRSP. While RRSP loans typically offer better interest rates than other loans, they usually require that the loan amount is contributed to an RRSP — often with the same financial institution offering you the loan.

RRSP loans can be offered as short-term or long-term loans, with terms ranging from 12 months to 10 years.

By using an RRSP loan to increase your contributions, you’ll have more funds to invest with tax-sheltered gains. In addition, you’ll lower your taxable income and potentially get a tax refund. The tax refund can then be used to repay the RRSP loan.

How RRSP loans work

If you decide to get an RRSP loan, there are three strategies you can use to maximize the benefits while minimizing the cost of borrowing:

1. Gross-up strategy

The first strategy is to increase your current contribution by taking out a loan and paying it off in full before you have to begin making repayments. Some financial institutions allow you to defer payments by 60 to 120 days, which should provide you with enough time to receive your tax refund and apply it towards the loan before you have to make your first payment.

Let’s assume you live in Manitoba, you earn $62,000 a year (therefore, your marginal tax rate in 2024 is 33.25%), you have $15,000 in RRSP contribution room, and you’ve saved enough to make a $5,100 contribution. If you decide to borrow $2,500, you can increase your contribution to $7,600. This will result in a potential refund of $2,527 ($7,600 contribution x 33.25% marginal tax rate = $2,527), which will pay off the loan in its entirety (excluding interest).

2. Top-up strategy

The second strategy is similar to the first but in this case, your refund will pay off a portion of the loan. We’ll assume your salary and unused contribution room are still the same but you only have $2,000 to contribute. If you borrow $5,000, you’ll increase your total contribution to $7,000. This will result in a possible refund of $2,327.50 ($7,000 contribution x 33.25% marginal tax rate = $2,327.50). If you use your refund to help pay down your loan, you’ll pay off nearly half of it and owe $2,672.50 (excluding interest).

With the first two strategies, your loan term is usually for one year and the interest rate is often at or near the prime rate (currently 4.95%). Note that your rate may be higher if you don’t have a good credit score.

3. Catch-up strategy

The third strategy is where you borrow a large amount of money using a long-term RRSP loan — often marketed as a catch-up loan — to make the maximum allowable RRSP contribution. We’ll assume your salary and unused contribution room is the same, but you don’t have any money saved to contribute to an RRSP. If you get a $15,000 loan, this will result in a potential refund of $4,987.50 ($15,000 contribution x 33.25% marginal tax rate = $4,987.50). Using your refund can help pay off nearly one-third of your loan immediately (excluding interest).

The term for a catch-up loan is usually for two to five years although some financial institutions may offer terms of up to 10 years. Many institutions will let you borrow up to $50,000. However, longer-term loans often come with higher interest rates.