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.
Before applying, you need to decide whether or not it’s worth getting a loan. If you have credit card debt, you can’t afford to make additional loan payments, or the interest rate on the loan is very high, you probably shouldn’t get an RRSP loan.
But if you don’t have high-interest debt, you can afford to take on a loan, and qualify for a low interest rate on a loan, it might make sense to apply for an RRSP loan. If you decide to get a loan, there are three strategies you can use.
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 2016 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 by 49% 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).
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 by 250% 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 2.7%). Note that your rate may be higher if you don’t have a good credit score.
Catch-up strategy—The third strategy is where you borrow a large amount of money 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. And many institutions will let you borrow up to $50,000. However, longer-term loans often come with higher interest rates. For example, the variable rate on a one- or two-year loan at B2B Bank is currently 3.2%, but it’s 4.95% on a loan with term of three to five years and 5.6% on a loan with a term of six to 10 years.
The bottom line
An RRSP loan can help boost your retirement savings fairly quickly. If you decide to get a loan and can’t pay it off entirely with your tax refund, ensure you can take on additional debt. And if you do get a refund as a result of taking out a loan, it should be used to pay down the money you borrowed and not for a vacation or a shopping spree.