Clark Wealth Management Group - ScotiaMcLeod Fredericton

If you haven’t yet made the maximum contribution to your RRSP for 2010, or have unused contribution room from previous years, now is the time to consider an RRSP loan.
Whether or not you should borrow to invest in your really depends on your financial situation. This is where a qualified advisor can help.

Option 1 – repay your loan in 1 year:
The general rule of thumb is that as long as you can pay back your RRSP loan within the year, you are better off than if you do not make the contribution at all. For example, if you borrow $10,000 at 5%, your monthly payment would be $856 and your total principal and interest payments for the year would be $10,273. If your RRSP grew at 6%, the total value of the contribution after one year would be $10,600.

After one year, you are already ahead by $327. This does not take into account that by making this contribution, you may be eligible for a tax refund. If you are in the highest marginal tax bracket (43.3% in New Brunswick), your $10,000 RRSP contribution will result in a tax refund of up to $4,330. If you use your refund to pay down your RRSP loan, this scenario gets even better as it will reduce your loan to approximately $5,600.

Option 2 – repay your loan over several years:
What happens if you are unable to pay back your RRSP loan within the year? This may be the case if you have large amounts of unused RRSP room. For example, if you had $50,000 in unused room and were able to get a 5% loan for 5 years, your monthly payments for the first few months would be roughly $950. The tax refund generated from the contribution ($21,650 assuming the highest marginal tax bracket in New Brunswick) should be used to pay down your loan. Once you have reduced your outstanding loan by the tax refund you have two choices, you can either continue to pay $950 a month, which would result in you paying off your loan in about 2 years and 9 months. Or, you can keep your 5-year term and reduce your loan payment approximately $470. Clearly though, the sooner you pay off the RRSP loan, the better off you will be because it will minimize the loan interest you pay.

Either way, the RRSP should grow while you’re working on paying off that loan. If your RRSP grew at 6%, you would have roughly $66,900 in 5 years. $89,500 in 10 years and $160,300 in 20 years.

As you can see from the above example, people that benefit the most from long term RRSP loans are those who have many years until retirement. The advantages of borrowing are most effective if the money can benefit from tax-deferred growth inside the RRSP (in excess of the interest payable on the borrowed money) for many years. Remember the interest on a loan for your RRSP is not tax deductible.

Here’s the Bottom Line. If the only way you are able to contribute to your RRSP this year is to take out a loan it may be a good idea. However, the longer the loan is outstanding the more non-deductible interest you will end up paying.

Keir Clark, is a senior wealth advisor, with Clark Wealth Management Group and branch manager at ScotiaMcLeod in Fredericton, NB. He can be reached online at www.keirclark.ca or by telephone at 506-450-6465.

Information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, expressed or implied, is made as to the accuracy or completeness.