Episode 81 – Pros and Cons of Borrowing Money for Your RRSP Contribution
Don’t get stuck in an endless borrowing cycle.
It can be tempting to take out a loan for your RRSP contribution—but keep in mind that current lending rates are high, and this could lead to a longer borrowing span than you had intended.
In this scenario, it’s easy to catch yourself in the non-stop cycle of borrowing money for next year’s contribution …
And the next after that. You get the picture.
There are pros and cons to borrowing money for your RRSP contribution. Before you decide whether or not it’s the right move for you, tune into this podcast episode to discover the good and the bad.
Hey there and welcome back. We are gearing up for tax time, and the big question this week is: Should you borrow money for your RRSP contribution? Today, I’m gonna give you some insight into taking out an RRSP loan. It might be tempting to take out a loan if you don’t have the cash available to make a contribution.
The idea is that you make a contribution, invest in your RRSP, and then turn around and use the tax refund to pay down the RRSP loan. Let me put this a little bit more accurately for you. So the bank gets to loan you money and charge you an interest rate, and they get you to invest in a product that they own that pays a management fee and advisor fee to them.
This sounds great for the banks. No wonder the commercials and advertisements are big right now on the banks. In fact, right on the institution website, I’m pretty sure there’s a tab that you can click to apply online for your RRSP loan—quick and easy virtual loan without a real human needed.
I might have a more positive attitude and humour this discussion a little bit more if prime lending rate was under 2%. Okay, so here is a con to this scenario. Negative situation is that high lending rates right now and the possibility of an endless cycle of borrowing money. So our interest rates are high. You get yourself into a dog chasing its tail—nonstop boring money for every year’s contribution.
If it takes you a few years to pay back the loan., and every year you need a top up, you will have perpetual loan payments that seem to never end. What I mean is that you could potentially be making payments on last year’s contribution for the rest of your life, and at some point you will have to break the cycle.
Okay, to be fair with you—devil’s advocate—I will share a positive side, a possible scenario that is a positive side of topping up RRSP contribution room with a loan. Let’s say it’s a one off. You have one huge earning income year, and all of a sudden you have this extra RRSP room, or you wanna do this huge catch up and maximize out on room that you’ve had for the perfect scenario.
Imagine you are in the top tax rate, let’s say 46%, and you maximize your RRSP room and have the benefit of compounding returns for many years until you retire. And you can afford to pay off the loan ASAP, let’s say in one year, and you also have extra surplus cash flow to continue on with RRSP savings for the next year’s available room.
Then this outcome could be okay, but that means repayment in one year, you are in the top tax bracket, and borrowing interest rates are low, and you have a long timeline until you retire to allow that compounding interest to grow.
Oh, and you have the extra cash flow to not have to do a loan again for next year’s contribution room. If you are going to borrow for your RRSP contribution, that is a lot of check boxes to be checked off that I just gave for it to be a positive outcome.
My last 2 cents on this: Truly disciplined investors with a plan and strategy don’t need to pay extra interest on borrowed money for their RRSP savings right now, especially in this high interest rate environment. I generally do not recommend getting into that cycle of constant borrowing to save. That’s it. Any questions, send me a note: [email protected].