Is an RRSP loan smart?

Should you consider taking out an RRSP loan before the March 2 deadline? While the promise of a big tax return may be tempting, the answer for most people is no.  

An RRSP loan is a basic investment loan where you borrow money now and fully invest it into your RRSP and then pay off the borrow sum over a period of time. These loans can seem pretty attractive right now with the promise of a larger than normal tax return and low interest rates but before you sign on the dotted line, make sure you really think things through.  

In order for the RRSP loan strategy to work, you need to be earning more growth in the RRSP than what you pay in interest. But there is no way to guarantee this as the only guaranteed type investments (such as GICs) are paying far less returns than the interest you would have to pay on the loan. So without a high enough guaranteed investment return, the RRSP loan might subject you to more risk than necessary with current market volatility.    

Having said that, there are some cases where it may still make sense. Who would it make sense for? If you had an unusually high income year in 2019 and want to offset some of these earnings that would be taxed at a higher rate, an RRSP loan might be the way to go.  

Ideally you would just take some of this extra income earned and invest it directly into your RRSP to offset the taxes. If the higher income earned was used elsewhere though, such as being re-invested in a business or to pay down debt, this strategy just might work.     

But, and this is a big but, the strategy could work only if you have the ability to pay the RRSP loan off fairly quickly. While some RRSP loans offer repayment plans up to 10 years in length, I would not recommend doing so. Although interest rates are low right now, the RRSP loan is still adding to your overall debt which can set you further behind in your financial and retirement plans. Ideally, you should plan to pay off an RRSP loan in one or two years at most.  

By making the lump sum contribution though the loan, you will potentially get a decent sized tax refund in the spring assuming you’ve already paid taxes throughout the year. If so, this tax refund should be used to immediately pay down a portion of the RRSP loan as well. This will reduce the overall interest paid during the life of the loan and make it easier to pay off the remainder more quickly.  

Each year, I have numerous people ask me if it’s a good idea to set up an RRSP loan before the deadline at the end of February. After reviewing their situations, I recommend against using this strategy for at least 80 per cent of them.  

The remaining few that I do recommend using an RRSP loan for usually have very specific situations that dictate this type of plan. I am sure this puts me in the minority as many investment advisors will happily sell you an RRSP loan since it means more investment assets on their books.  

So take that as your warning if your financial advisor or institution is recommending an RRSP loan strategy this year. Take a few minutes to decide if it’s really right for you. For most, my guess is it just doesn’t make sense.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.