Borrowing To Invest In RRSPs – Is It Really Worth It?

Although we are a few months away from Registered Retirement Savings Plan (RRSP) season, it is important to plan for tax time and know your options long before that last-minute call to your advisor. RRSPs are a great tool to plan for retirement in an age where pension plans are slowly disappearing. In addition, the benefit of deferring tax by contributing to your RRSPs make them a very attractive investment vehicle.

With recently low interest rates, borrowing to invest in RRSPs seems to be an increasing trend. Although there are times when this is a viable option, it tends to be used more often in situations that are not ideal. Here are a few things to consider as you ponder whether you should borrow to invest in RRSPs:

Do You Need To Contribute To Your Rrsp In The First Place?

Contributing to RRSPs is mainly about managing tax brackets in order to defer tax. In an ideal scenario you want to contribute today using your RRSP deduction to reduce a high tax bracket, and withdraw at a later date using the RRSP income inclusion to increase a low tax bracket. If your current year RRSP contribution will reduce taxable income that is already in a low tax bracket, you should consider investing in a Tax-Free Savings Account (TFSA), or even investing in a non-registered investment.

In cases where you have large income in one year due to an extraordinary event, such as a rental property sale, borrowing should be considered as the differential between your current-year tax bracket and your subsequent year tax bracket may be significant enough to outweigh the costs of borrowing.

What Interest Rate Will You Be Paying?

It is important to be aware that interest payments on funds used to invest in RRSPs are not tax deductible. If the interest rate you are paying on borrowed money is higher than the rate of return on your RRSP investments, borrowing may not be the best idea. Also, if your loan includes a variable interest rate, you need to consider that interest rates might increase over the coming months.

How Quickly Will You Pay Back The Loan?

If you have determined that borrowing to invest in an RRSP might make sense, you need to consider that in most situations there is only a net cash benefit if you can pay off the loan within a year.

As an example, here is a simple situation where borrowing to invest in an RRSP may make sense: Let’s assume you have $5,000 of unused RRSP contribution room, $3,250 set aside in cash, access to $1,750 from your line of credit, and you are in a 35% marginal tax bracket. If you contribute $5,000 to your RRSP using the $3,250 in cash plus the $1,750 from your line of credit, you will generate a tax refund of $1,750, equaling the amount on your line of credit. The refund can be used to pay off the line of credit and you pay only a small amount of interest over the two to three months the line of credit was utilized.

What Other Options Are Available?

If you have determined that borrowing to invest in your RRSPs is not the best option for you, here are a couple of alternatives to consider:

Borrow to invest in non-registered assets: Under this option, the interest payments on your loan are tax deductible.

Cash out non-registered investments to invest in RRSPs, and then borrow to reinvest in your non-registered investments: Under this scenario you have the desired RRSP deduction as well as tax deductible interest payments. The potential tax generated on the disposition of your non-registered investments will need to be managed; however, done properly the desired results can be achieved. Note that transferring directly from a non-registered investment into your RRSP is still treated as a disposition for tax purposes.

Monthly RRSP contributions: The best answer for most people is to use the cash that you considered putting towards monthly debt payments and make monthly RRSP contributions instead. If you are stuck in a cycle of annual RRSP loans and repayments, taking a year off to achieve this will put you much further ahead in the long run due to the reduced interest payments.

Remember that each individual’s situation is different. It is extremely important to seek the advice of your financial advisor prior to making any decisions. Planning for retirement is extremely important; combining retirement planning with proper tax planning is even more critical.

Tim Adams, CPA, CA is a partner at the Waterloo office of MAC LLP. In this capacity he provides accounting, assurance and taxation advice to corporations, individuals and not-for-profits alike. He can be reached at tadams@mac-ca.com. For additional information visit MAC LLP’s website at www.mac-ca.com.