RRSP Loans

The deadline of March 1, 2012 for contributions to an RRSP to be tax deductible for 2011 is fast approaching. While it goes without saying that you should maximize your yearly contributions, some individuals cannot afford to do so. But don’t let a lack of cash prevent you from utilizing this powerful financial tool.  One option available to investors is an RRSP loan.

An RRSP loan will not only allow you to maximize your contributions, it will increase your growth potential through compounding (the larger your initial investment and the longer it remains invested, the greater your investment growth) and reduce taxes.

To help illustrate the benefits of using an RRSP loan, consider the following scenarios.

Scenario 1:

You take out a $10,000 RRSP loan at 6% and invest it immediately. Assuming a marginal tax rate of 40%, this $10,000 contribution will result in a $4,000 refund. You can use this refund to help pay down your RRSP loan and repay the remaining balance, plus interest, over a 12 month period by paying $516 a month. Assuming an 8% annual return, in 20 years the $10,000 will have grown to $50,338.

Scenario 2:

Now assume that instead of using an RRSP loan, you invested $516 per month, for 12 months, for a total contribution of $6,192. If we again assume an annual return of 8%, in 20 years the $6,192 will have grown to $30,823.

So the investor in scenario 1 who utilizes an RRSP loan has the same monthly cash flow as the individual in scenario 2, yet their investments experience a growth difference of  approximately $19,515 over 20 years.

An RRSP loan is also a great way to reduce debt. For example, assume that you have $4,000 in credit card debt with an annual interest rate of $19%, resulting in payments of $369 a month over 12 months.  Similar to scenario 1, if you take out a $10,000 RRSP loan at 6% and invest it immediately, you can use the $4,000 refund to pay off the credit card debt. You can then pay off the balance of the loan, plus interest, for $369 a month over 17 months, again keeping your monthly cash flow the same, but with the added benefit of having $10,000 invested for your retirement.

Finally, since an RRSP contribution results in a deduction and hence, lower net income, any income tested credits, such as the Child Tax Benefit and the GST credit,  will be increased.