RRSP Loans: Why You Should (and Shouldn’t) Get One
February is RRSP season, which for many Canadians means an annual trip to the bank to make an RRSP contribution before the deadline (March 1, 2023). It might be tempting to take out a loan if you don’t have the cash available to make a contribution – the rationale being that in one shot you’ll boost the savings in your retirement account and then use the deduction to increase your chances of getting a tax refund.
RRSP loans are great for banks because they get the loan, plus an investment on their books. No wonder lenders so heavily promote RRSP loans at this time of year.
Related: How to get more out of your RRSP this year
It’s not just Canada’s big five banks pushing RRSP loans. Online banks and lenders are also getting in on the act. Tangerine bank customers may have been surprised to find a pre-approved RRSP loan listed on their ‘My Account’ dashboard:
Most RRSP loans are used to make an RRSP contribution before the deadline in order to maximize contribution room and save on taxes. Interest rates on these loans can be obtained at or near prime rate, and the loan is paid back over a period of nine to 12 months – typically in monthly installments.
Borrowers beware. Financial institutions, both of the online and brick-and-mortar variety, employ salespeople and develop promotional materials, charts, and testimonials with the aim to convince you that a loan is a good idea. It might not be.
A chart that tries to highlight the tax savings on an RRSP contribution, for example, might show a borrower in the highest marginal tax rate to make the figures look good. If you happen to be in a lower tax bracket, you’ll get less of a refund.
One behavioural argument against taking out an RRSP loan is that if you didn’t have the discipline to contribute regularly to your RRSP throughout the year, how do you expect to stick to a loan repayment schedule over the next 12 months?
Financial author Talbot Stevens says our behaviour is the key to making the RRSP loan strategy successful.
“Even an undisciplined investor can benefit from the forced savings of paying off a loan – as long as it is well within their financial and emotional comfort zone,” he said.
Small top-up loans are generally accepted as a sound financial planning strategy and Stevens argues that once started, the RRSP loan becomes a forced savings plan, like a mortgage, that is not likely to be stopped.
With that in mind, let’s use an example of an investor who is in a 40% tax bracket, has $1,000 to contribute to her RRSP before the deadline, and has $5,000 in available contribution room.
Related: Are you putting dry pasta in your RRSP?
A short-term RRSP loan can top-up her annual RRSP contribution to the maximum. She simply borrows the extra $4,000 to make a $5,000 contribution and, at tax time, she’ll receive a $2,000 refund. The refund is not enough to pay off the entire RRSP loan, but she applies it against her loan and then pays off the remaining $2,000 balance over the next year.
This type of approach can boost your retirement portfolio in a hurry, but it can also lead to an endless cycle of borrowing ahead to catch-up on RRSP contributions. Can you afford to make regular RRSP contributions when you’re constantly making payments on last year’s contribution? In other words, at the end of the RRSP loan you might have to catch-up the contributions you didn’t make while you were repaying the loan.
At some point you’ll have to break the cycle. With that in mind, a debt-free approach to RRSPs would have you determine the amount you would have made in RRSP loan payments, then, use that amount to make regular RRSP contributions going forward. It may take a while longer to catch up but you’ll have no interest costs.
Final thoughts on RRSP loans
Using an RRSP loan can be a powerful strategy to boost your RRSP contributions and build your retirement portfolio. However, use caution when borrowing to invest and remember that this approach only works when you have the discipline to save your tax refund or use it to help pay off the loan.
Related: How an RRSP loan turned my $12,000 contribution into $20,000
Banks fuel our need for instant gratification with their well-timed marketing during RRSP season. But an RRSP loan isn’t necessary if repaying a loan doesn’t fit into your financial plan, or if you had the discipline to make regular contributions to your RRSP throughout the year.
“Truly disciplined investors don’t need the forced commitment of an RRSP loan. Those who acknowledge their tendency to procrastinate or become distracted from their retirement goal might benefit from the forced discipline of making payments on an RRSP loan,” says Stevens.
Well said.
I usually take RRSP loan when there’s a plunge in the stock market. That’s why I prefer to keep and accumulate my contribution room and then when a plunge comes I take a loan (Tangerine), almost for free, and put gradually in my RRSP fund (100% equity), and pay 12 months back. Next year I get a refund. Very smart approach in my view. You’re welcome!
Sorry, maybe it’s too early in the morning for me to understand. You will not contribute to your RRSP if the market is doing good. When it falls, you borrow money and make periodic contributions. You are also paying interest on borrowed money that is not invested. If you have the money to make the loan payments over 12 months, why are you not just depositing directly to your RRSP?
You never know when the plunge will come, like in Dec 2018 or Mar 2020, if you just depositing to your RRSP and keep it in cash and waiting – there’s an opportunity cost. I’m not paying interest on borrowed money that is not invested because I borrow money when the plunge already happened, I just split the total abound for 3-4 portions and step in during a couple of weeks.
Hi Andrew, it’s an interesting strategy but the evidence suggests ‘buying the dip’ is sub-optimal compared to being fully invested at all times: https://www.pwlcapital.com/resources/buy-the-dip/
This study looked at investing immediately versus dollar-cost-averaging over time versus waiting for a correction before investing fully. “Buy the dip” was the worst performer of all three strategies.
Even the idea that you would consider leveraged investing but haven’t yet because you’re waiting for a market pullback means that you’d actually be better off doing the leverage immediately and stay fully invested.
The opportunity cost of waiting for the dip to occur is what drags down the potential returns (versus the other two strategies).
Just to be clear — I’ve seen this “March 1” deadline for RRSPs mentioned in numerous places. That is the deadline for contributions for 2021, right? Sorry if this is a silly question — I moved to Canada recently from the US, and last year was my first of having RRSP room. I maxed mine out by the end of December, but it seems like I could have waited a couple of months if I understand this correctly.
Yes, you have 2 months past the end of the year to make 2021 contributions. I think the logic is to see what your total salary is and then have time to maximize RRSPs which can be a tax deduction. Nothing wrong with maxing out early but the deadline is always around March 1. Your RRSP tax receipts come (usually) in two parts – Mar – Dec and Jan -Feb. Mine always have been anyway.
If, like me you have work contributions as well (come automatically off my pay) then those contributions will also count and I always have to make sure I leave room for the first 4 pays in my RRSP contributions for the previous tax year. You can get stung if you over contribute.
Thanks! Just to clarify — does that mean my work contributions for January and February are counted to my 2021 RRSP room? Or do I have the option to allocate them to either 2021 or 2022? If they go towards 2021, then I’ve gone over…
As far as I have always known, it counts to 2021 but…you might be able to defer and claim the contribution in 2022. But that is a question for someone much more versed in tax language than me. As horrible as it can be to call CRA – you might want to ask the question…or call a tax accountant.
Well, I’m using a tax account this year, and I asked him, and he confirmed what you said. The good news is, given my bi-weekly contributions, I should only go over the $2000 cushion by $11.16. I *think* all I need to do is pull that extra $11.16 out and pay taxes on it, but I’m waiting on confirmation from my tax accountant. I could also ask my employer to skip my final RRSP contribution for February (which would keep me under the $2000 over contribution cushion) but I hate to give up the match. 🙂
Thanks for making me aware of this!
Your 2022 RRSP deduction limit won’t be officially set until you file your taxes for 2021. So if you’ve maxed out your RRSP room and gone over the $2,000 over-contribution limit then you’ve exceeded your contribution room and would need to remove the excess or face a 1% per month penalty on the overage.
That said, making the contribution and claiming the deduction are two different things. You could claim the deduction in a future year.
Once you find out your 2022 RRSP deduction limit I’d suggest adjusting your contributions so that the employer-employee combination does not exceed that limit going forward.
Good day,
Can you borrow from brick and mortar bank and invest via Wealthsimple Trade?
No reason why not. However, the RRSP loan at a bank may be at a lower rate with the condition you invest in that bank’s product. A loan to invest at another institution would likely be at a higher rate.