What is an RRSP Loan?
An RRSP loan is a type of loan where the funds are used exclusively to contribute to an RRSP account.
The idea behind an RRSP loan is simple: you borrow funds, deposit them in your RRSP account to realize tax savings, and then pay off the loan over time.
Meanwhile, the borrowed funds grow in your account tax-free.
An RRSP loan is an appealing option if you lack the cash needed to contribute to your RRSP in the present day.
By borrowing money, you ensure consistency with your annual contributions and stay on track toward your retirement savings goal.
Advantages of an RRSP Loan
Borrowing from a financial institution to contribute to your RRSP provides you with several advantages.
A lower tax bill
One of the rewarding aspects of an RRSP is the hefty tax refund you could potentially receive due to your annual contributions.
Luckily, contributions originating from a loan accomplish the same objective.
By deducting the loaned funds on your tax return, you end up with a reduced tax bill, which you otherwise would have missed out on.
Extra investment growth
One of the advantages of an RRSP is that the funds held within it grow tax-sheltered until you decide to withdraw them.
By borrowing money to deposit into your account, you can benefit from extra investment growth.
Consistency is one of the keys to successful investing for the long term, especially when it comes to retirement planning.
To reach your target balance, you must diligently set aside sufficient funds each year to invest.
Even missing a single year of contribution can set you back, particularly if you fail to contribute when your investment portfolio is experiencing rapid growth.
You should always strive to take advantage of a bullish economy by maximizing your RRSP contributions.
Are you carrying a large chunk of unused RRSP contribution room every year and are eager to put it to work? If so, you can easily play catch-up by taking out an RRSP loan and filling the gap.
As long as the rate of return on the investments in your RRSP account exceeds the loan’s interest rate, you’ll come out ahead.
Low interest rates and flexible payment terms and benefits
RRSP loans generally come with low interest rates, primarily those offered by traditional financial institutions.
The rates are equal to financial institutions’ prime rate or the prime rate plus a small markup.
In addition to attractive rates, many financial institutions provide borrowers with flexible loan terms and other benefits, such as:
- Deferral of your first repayment for up to 90 days
- No prepayment penalties
- Automated payment options
- Loan terms ranging from 1 to 10 years
- Ability to borrow from $1,000 – $50,000
Disadvantages of an RRSP Loan
Just as there are benefits to topping up on your RRSP account with borrowed funds, there are also disadvantages to consider.
Potential debt problems
When considering an RRSP loan, remember that it has to be paid off just the same way as any other personal loan or credit card bill.
Be sure you assess your current budget to see if you’re comfortable committing to additional debt.
Otherwise, you can quickly become overwhelmed with debt payments, leading to a dwindling disposable income, impaired credit score, and potential bankruptcy.
Decreased ability to borrow
By taking on an RRSP loan, you tack on another liability to your personal balance sheet.
Depending on the size of your debt relative to your income, the addition of an RRSP loan can hinder your ability to obtain other forms of financing.
For example, lenders will evaluate your financial profile to assess the risk of extending a mortgage to you.
One of the metrics they employ is the Total Debt Service Ratio (TDSR), which measures how much of your income you use to service your debt obligations.
If they see that you’re using a substantial portion of your income to cover your existing debt, they’ll consider you a high-risk borrower and may be wary of offering you a mortgage at a favourable rate or may decline the loan altogether.
Interest is not tax-deductible
Unlike interest charged on loaned funds invested in a non-registered account, the interest you pay on an RRSP loan is not tax-deductible.
What this means is that the cost of borrowing for an RRSP loan is higher since you receive no tax break.
Therefore, you must earn a higher return on the loaned funds you deposit in your RRSP account to offset the higher cost of borrowing.
Should I get an RRSP Loan?
Whether or not you should get an RRSP loan depends on several factors, including your debt load, tax bracket, and cost of borrowing.
It makes sense to apply for an RRSP loan if you carry little debt, are in a high tax bracket, and can secure a loan rate lower than your expected rate of return on your RRSP investments.
You’ll have to crunch some numbers to determine if borrowing money is economically feasible for you.
At the minimum, you want to ensure you’ll realize enough tax savings and investment growth to cover the loan cost.
Conversely, if you’re heavily in debt, are in a low tax bracket, and can only borrow at a high rate, seeking an RRSP loan isn’t worthwhile.
Frequently Asked Questions
- How long do you have to pay back an RRSP loan?
In general, most traditional lenders offer RRSP loans with terms ranging from 1 – 10 years. Naturally, loans with short terms entail larger monthly payments, while those with more extended periods require smaller monthly payments.
- How much interest do you have to pay on an RRSP loan?
Interest rates on RRSP loans vary from lender to lender, but borrowers with the best credit scores can access rates as low as the bank’s prime rate
Typically, lenders add a percentage between 0.75% – 3% to the prime rate. This markup is based on factors like the borrowers’ credit standing, income, and assets. In addition, the loan’s size and term influence the rate assigned to borrowers, with larger loans and longer repayment schedules incurring higher rates.