I’ll admit I’ve never liked the idea of taking out an RRSP loan to boost contributions and generate a higher tax refund. If you can afford to pay back the RRSP loan over 12 months then you probably should have budgeted and saved for higher contributions in the first place instead of borrowing.
However, after re-reading The Wealthy Barber Returns last month, I got an idea that would increase next year’s RRSP contributions by 67 percent with minimal cost and effort. I took out an RRSP loan and here’s how it works:
I’ve already contributed $11,100 toward my RRSP this calendar year, but because $5,100 of that was claimed in the first 60 days for last year’s taxes, I’ll have a total RRSP contribution of $6,000 for this tax year (2013).
My marginal tax rate is 32 percent, so that $6,000 RRSP contribution would generate a tax refund of $1,920.
I’ve budgeted $1,000 per month for RRSP contributions in 2014, or $12,000 for the year.
A Simple Idea
According to Chilton’s, “A Simple Idea” chapter, most of us save from our after-tax income but by doing so we shortchange our RRSPs and then we often add financial insult to injury by spending our tax refunds.
Related: Why do we save?
In his fictional example, “Todd” had $3,000 saved for an RRSP contribution and Chilton advised him to contribute $5,000 because that amount would generate a $2,000 tax refund which will cover the amount borrowed.
Where does Todd get the extra $2,000 to make that contribution?
“I don’t care where you get it, just get it,” Chilton advised. “Transfer it from your emergency fund account, borrow it from your sister, take it from your line of credit. Remember, you’ll get it back in May or so. At five percent, the interest over four months will be less than $35. But you’ll have contributed 67 percent more to your RRSP!”
My $20,000 RRSP Loan
With that in mind, I borrowed $20,000 from the bank in the form of an RRSP loan at four percent. Monthly payments will total $1,703 starting in January and ending in December.
Related: Is an RRSP loan necessary?
That increases my 2013 RRSP contributions to $26,000, which will generate a tax refund of $8,320. Remember I had budgeted $12,000 for RRSP contributions next year. After applying the tax refund to the RRSP loan sometime this spring, I’ll still only be out of pocket $12,000 for the year, but my RRSP will have an extra $8,000 using this approach.
Two caveats with this strategy: I’ll need to come up with an extra $703 per month to pay the loan until my tax refund comes in, and the full cost of borrowing $20,000 for 12 months will come to $435. But if I apply the entire refund at once and then continue with the same repayment schedule I’ll pay off the loan in August and save a few hundred bucks interest.
Using an RRSP loan (or borrowing from your sister) can be a powerful strategy to boost your RRSP contributions and build your retirement portfolio. However, use caution whenever borrowing to invest and remember that this solution only works when you have the discipline to save your tax refund or use it to help pay off the loan.
Related: Smart tax planning strategies
Now if you’ll excuse me, I have some Christmas shopping to do and I’m looking for a sale on dividend growth stocks.