Regardless of how committed you are to saving for retirement, the reality is that you have a lot of competing priorities – mortgage and loans to repay, fun to have. If you simply don’t have the money to come up with an RRSP contribution you may think that getting an RRSP loan is the only solution.
RRSP Loan Season
Every year our financial institutions heavily promote RRSP loans. It’s a two-for-one special for them – a loan and an investment in their books.
Bank employees (advisors, account managers) are salespeople who will convince you to borrow.
They use the highest marginal tax rate when figuring out your tax savings. If you’re not in that tax bracket, it’s not what you will get. Furthermore, if you’re making a large contribution you might actually get less if the money you deduct moves you into a lower tax bracket.
If you can’t afford to take money from your cash flow to put into an RRSP what makes you think you can afford to take money from your cash flow to repay an RRSP loan that also has an interest cost? And the interest is not tax deductible.
You don’t lose contribution room so you can catch up next year. Don’t be swayed by the hype sold by lenders about the growth you’ll miss out on if you skip your RRSP contribution.
Catch-Up Loans
If you have a large amount of contribution room it may be tempting to take out a great big loan to catch up all at once. The bank will show you a scenario where you will get a huge tax refund that you could use to pay off outstanding credit cards and lines of credit. It may sound like a really good idea.
You’ll have a loan at 5% with a payment of $720 for 10 years but the money would be inside an RRSP growing on a tax-deferred basis. They will show you how much you’ll have in 25 years when you’re ready to retire. You’ll be happy in your ignorance because you never bothered to ask a really important question. What is this loan going to cost me?
Long-term loans usually will have a higher interest rate and if the total amount is almost what you saved on tax, the tax savings benefit has been significantly reduced.
Another problem is if your income level isn’t high enough to get full use of the tax deduction at the top marginal tax rate the lender used to project the tax refund. In reality, when the RRSP deduction is applied your income could fall into a lower bracket and you’d get less tax back.
With a loan repayment eating up a large slice of your budget how will you afford to make regular RRSP contributions going forward? At the end of the catch-up loan you would have to catch up the contributions you didn’t make while you were repaying the loan.
What Should You Do?
First, calculate the amount you would have made in loan payments for your catch-up loan. Then, use that amount to make your contribution to catch up on your unused RRSP room.
It may take a little longer to catch up but you’ll have no interest costs. All your money will be working for you instead of making the bank more profitable. Also, you’ll be able to invest slowly using dollar cost averaging to even out your entry costs.
Lenders play into people’s needs for immediate gratification. Saving and investing are long term, slow and steady propositions. If you want to catch up on RRSP unused contribution room, trim back your expenses or find a way to make some extra money to sock away what you want. Don’t over borrow!
