How An RRSP Loan Turned My $12,000 Contribution Into $20,000
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:
Related: RRSP contribution vs. Mortgage pay down
RRSP Contributions
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.
Final thoughts
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.
I think this is a neat strategy to force the discipline to use the tax refund for contributions: by taking out the loan first it then hangs over your head, making you much more motivated to follow-through on the plan to invest it (or now, pay off the loan) than spend it.
@Potato – Yes, and it also forces me to follow through on the $12,000 that I budgeted to contribute in 2014.
I failed to mention in the post that I have $30,000 in unused contribution room, making it possible for me to contribute $26,000 this year.
Wow – that’s a pretty nice chunk of change to invest in just one year 🙂
It’s a good idea for people to check exactly how much they can expect back in their tax refund before calculating how much they will have to pay for the loan. Some people are just slightly into a high tax bracket. As soon as they reduce their income by, say, $2000, they drop back into a lower bracket. That reduces their tax refund, sometimes considerably. Gail Vaz Oxlade warns about this in her recent book Never Too Late. The tax refund will also be lower if not enough tax was withheld at source on earnings, perhaps from EI during maternity leave, for example.
As long as it makes sense, tax-wise to do so, and you have the exact tax refund amount worked out, it’s a pretty solid approach. I’m not at a point yet where it makes sense to max out my RRSP contributions… so maybe in a few years we’ll do this and end up with the world’s largest tax return! (Kidding, though it would be quite large!)
Ok, but you are making this needlessly complicated. At the end of the day you are simply getting the extra refund for the RRSP contribution in the spring of 2014 as opposed to the spring of 2015.
@Matt – what’s complicated about this approach? It’s simply forced savings, plus I get the benefit of an extra year of compounding.
I would have loved to have been able to contribute that much to my RRSP when I was still working. The trouble was my pension adjustment (PA) was always a high figure which had to be subtracted from my “room”. The end all meant I was never able to contribute more than $5,000 +/- $1,500.
The government wants everyone to save sufficient funds for retirement yet puts obstacles, like the PA, in the way to quell savings!
@Bernie – the unused contribution room built up from 10 years working in the private sector. Now, in the public sector, my pension adjustment drops my RRSP contribution room down to about $3k per year. I’ll run out soon, probably next year, at which time I’ll try to max out my wife’s RRSP and then start working on our TFSAs.
I’m curious as to why you are going with the RRSP before the TFSA Robb. You must be in a high tax bracket?
@Stephen – My marginal tax rate is 32% and I had the unused room available. I’ve done the math and it favours the RRSP contributions over TFSA right now.
It still irks me that I had such a high pension adjustment number. I could understand it more if my pension was indexed or if it covered most of my needs in retirement. It only makes up about 27% of my retirement income.
@Bernie – yes, that would be tough to swallow, for sure. And no TFSAs back then, either.
I was a little confused at first, but I think I understand your strategy now. Instead of investing $18k over 2 years (2013 and 2014), you are investing $26k in 2013 and 0 in 2014. Makes a lot of sense that way, and it’s something I should def give some thought to. This year will be the first year I max out my annual contribution room, but I have a fair bit of extra room from previous years so it could e done. Of course, my mat leave top up runs out early next year, so now is not the time for taking out extra loans. I will def revisit this at the end of next year.
Great post!
This would have been a great strategy in 2008 for sure! I don’t think I’m going to rush to do this right away myself but if it was 2008 and I was thinking properly then I should done this.
I wanted to max out my HELOC to invest then but I thought betting the house was too risky and my wife would kill me if something went wrong so I decided against it.
@AdinaJ – You got it! Definitely worth a look if you’ve got the contribution room. Again, I’m not out of pocket any more than I would have been if I followed through with my intention to contribute $12k in 2014.
Interesting strategy, thanks for sharing. Have you considered using the funds to pay down the mortgage instead? With these rates, my guess is that for some people it doesnt make sense to pay anything extra towards the mortgage because the rates are so low
@Dave – I have a pretty aggressive mortgage pay down strategy as it is (basically doubling my minimum payment each month). Some would say that is too aggressive given the low rates, but I’m comfortable at that level as it still allows me to invest and use strategies like this one. Thanks for your comment.
Once I start working full time I’m definitely going to look into an RRSP loan, I think they are great especially when you make money on them!
Robb, I read your post when it arrived in my email box, and put a star to it as a reminder to recheck it again. During the Christmas break from work, I began preparing a few things for my and my wife’s tax returns. One of the items on my list was to check where we stood on the RRSP contributions this year, and how we could optimize them. Therefore, I went back to your post and re-read it couple of times more. I liked the idea so much, that I am going to take an RRSP loan too and will contribute $5000 more to my RRSP.
However, I have decided to do it in a slightly different way. Please, let me know if you see the logic behind my ideas and if not, why do you disagree.
Firstly, although RBC has pre-approved me for a $5000 RRSP loan, I have decided that I will use my HELOC instead. I haven’t spoken with a bank rep yet, but the interest rates used as an example on RBC’s website were somewhat high for my taste- 4.5%. My HELOC interest rate is only 3.5%, so I will save a few dollars. Also, I could have taken the RRSP loan from Canadian Western Bank at 3%, but their condition is to lock the money in one of their GICs or buy their mutual funds products. Since I didn’t like either one of those, I am using my HELOC instead. The funds will get deposited into my RRSP Self-directed account, and I will buy some blue chip dividend stock that I like.
The second idea was to take the loan in the last week of February. Each year, usually by the end of March, I file our tax returns. My expected refund usually gets deposited in my bank account not later than a week. This way, I will repay the loan almost immediately and save on interest payments too.
My question to you is why didn’t you do the same? Perhaps, the overall numbers would have been different in order to generate sufficient tax refund to pay off the entire loan right away. Nevertheless, once you have done it, you could still budget and do monthly contributions towards the new tax year, instead of paying off the loan.
Finally, there is one more advantage for me doing it my way. In general, I expect mine and my wife’s income to increase next year. If I take out a big RRSP loan and use my after tax dollars to pay it off, I will end up with $0 contributions towards 2014 Tax year. In order to avoid overpaying in taxes next Tax season, my only option would be to take another RRSP loan. Doing it my way, I will contribute during the year, assess the situation when the time comes, and if need be, take a small loan to top off my contributions.
Anyway, your post was great, and I regret not using this strategy in previous years. I guess it’s better late than later, right?
Happy and prosperous 2014 to you and your family!
@Elemag – thanks for the great comment! I like how you’ve thought this through and come up with your approach.
I don’t have a HELOC, so I’d have to apply for one if I wanted to borrow on it to invest. The rate on HELOCs at TD is 4%, which is the same rate offered for the RRSP loan, so I saw no advantage there.
I also like the structure of the forced loan repayment over 12 months rather than the flexibility to pay it off “whenever” on the HELOC.
I tend to be a bit impulsive which is why I chose to implement the strategy now instead of waiting until the end of February. I took out an RRSP loan once before in late February and was “forced” to place it in a GIC. This way I had the time to choose the right loan and be able to get it into the right product without having to make a hasty decision.
While I am sacrificing a bit of interest by taking out the loan a few months early, hopefully I can make up the difference (and then some) by investing that money earlier and earning some dividends over that time.
@Elemag – One more thing. I had a bunch of unused RRSP contribution room and this contribution has used most of it up. I now contribute to a DBP at work, which means I only get about $3,000 per year in contribution room. My ability to make large lump sum contributions to my RRSP will be severely restricted going forward, so this was a way to get that contribution room used up more quickly and take advantage of compounding.
Robb, thank you for your reply. The difference in our approaches comes from our different situation. The lesson for me was that I can use the bank’s money to lower my tax bill and at the same time use my after tax income to contribute to my TFSA, make extra payments on my mortgage, etc.
Hi Robb
I am currently learning how to establish some sort of retirement funding and found this post and its following comments exceptionally informative.
At this point one of us has a pension and the other nothing in place. Our cash flow has only allowed for a $400/m or $4800 yearly contribution which we can face as ‘better then nothing’ but not nearly the amount we would need to build a nice retirement without a pension.
An advisor had explained that we could take a yearly RRSP loan for the amount of our expected return based on our tax bracket and contribute it all back in each year. We love this idea and will be doing so.
We have a very large 100k+ amount of contribution room. As a second, more aggressive approach he had explained that we could take a large loan in our HELOC of $75000 to place into our RRSP fund and maximize the returns claiming $15000 a year over a 5 year span and place them all in. He has explained that based on our current HELOC payment schedule the amortization being 12 years with the added $75000 adds a few years to pay off but we have then been compounding starting now. What do you think of this approach? He had originally showed us with maxing the contribution room to its max but we were uncomfortable with taking a major amount on our HELOC.
Hi Robb, looking back at this article now, are you still satisfied with your strategy, how has it changed in recent years?