Is an RRSP Loan worth it?

It's no wonder that saving for your retirement can be so difficult as there are so many other things that need a piece of your income every month. Whether it's inflation, your mortgage payment, saving in your kids RESP, or a large, unexpected expense.

Many Canadians struggle with making regular contributions to their Registered Retirement Savings Plan. They have plenty of RRSP contribution room. They’re just lacking the funds to put in an RRSP.

But there’s a way you can play catch-up: borrowing to invest with an RRSP loan.

What is an RRSP Loan

A RRSP loan allows you to borrow money specifically to contribute to a RRSP. Since it’s a loan, you pay interest on the money you borrow.

Most people take a loan to make a RRSP contribution so that can both maximize contribution room and save on taxes.

What are the benefits of an RRSP loan?

It can reduce your tax bill and result in a refund from the Canada Revenue Agency. You can then use that refund to pay back your RRSP loan entirely or partially.
You can also use the tax refund to contribute more to your RRSP as well. This gives your RRSP a large balance to compound on over time in your retirement.

How does an RRSP loan work?

Here's an example of how a RRSP loan can work.

Imagine Jay is a typical Canadian saving for his retirement:

He is 35 years old.
His marginal tax rate is 40%
He contributed $3500 to his RRSP this year.
He then borrows $3000 from his bank to contribute to his RRSP, making total contribution $6500.
Now, his total refund comes out to the same amount as the loan. ($4,500 + $3,000 = $7,500 x 40% = $3,000). This means:
- He can pay off the loan right away with minimal interest, and
- A bigger RRSP contribution means more money to compound over the 30 years until he plans to retire. So, his portfolio could be larger overall.

How do today’s interest rates affect an RRSP loan?

Generally, you can get an interest rate at or near prime on RRSP loans.

So, for an RRSP loan to be worth it, your investments need to outpace the interest rate you’re paying the loan.

Rates of return on RRSPs can vary among investments and investment styles. So, if you’re paying 4.25% interest for the loan, but your investments produce more than that, you’ll come out ahead.

Financial experts recommend investing:

for the long term (10 or more years)
in products that have the potential to achieve a higher rate of return over time than the interest rate of your loan. (i.e. equities).

Otherwise, the interest on the loan could outpace what you make on your investments.

How long will it take you to pay back an RRSP loan?

When it comes to borrowing and paying back an RRSP loan, most financial institutions:

let you borrow a certain amount for a 1-to-10-year term
don't require you to start repaying the RRSP loans for 90 days.
allowing you to repay more than the minimum amount at any time. This can allow you to save on interest.

Is an RRSP loan right for you?

An RRSP loan is not the right solution for everyone. Whether you’re a prime candidate for an RRSP loan depends on your:

age (20s, 30s, and early 40s)
tax bracket (the higher, the better)
ability to pay down debt

You also need to make sure the loan payments fit into your budget without hurting your cash flow. If paying down your debt is a concern, again, you might want to focus on making regular RRSP contributions instead.

Whatever you do, be sure to discuss your options with an advisor before committing to a loan.

Investing

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