RRSP Loan Strategy

What is an RRSP Loan?  It’s a loan, typically offered at prime, that allows the borrower to contribute to their RRSP using the banks money.  The upside is that the borrower gets the tax refund in a few months, the downside is that the borrower is stuck with a loan that is paid out of cash flow.

To be upfront with you, I’m not a big fan of RRSP loans.  The only way that I would consider a RRSP loan is if the total tax return would cover the WHOLE loan.

In other words,  I would only borrow to “top up” my contribution (if I had the contribution room) so that my tax refund will be enough to pay off the underlying loan.

Below is some boring math that I figured out.  For those of you who bore easily, skip to the final equation.

RRSP Loan Amount (RL) = Total Tax Refund (TR)

TR = RRSP Contributions (RC) x Marginal Rate (MR) + RL x MR

Since we want:  RL = TR

RL = (RC x MR) + (RL x MR)

RL – (RL x MR) = RC x MR

RL (1-MR) = RC x MR

RL= RC x MR/ (1-MR)

In plain English:

RRSP Loan = (RRSP Contribution x Marginal Rate) / (1 – Marginal Rate) 

So to use this equation, say you contributed $5k to your RRSP this year @ 40% marginal rate.  If you have the contribution room and considering using a RRSP loan, I would only get an RRSP loan the size of the tax refund.

Therefore,

RRSP loan = $5k x 0.40/ (1-0.40) = $3333

Working backwards:

Tax Refund = ($5K x 0.40) + ($3333 x 0.40) = $3333

This strategy works best if you initiate the loan/contribution just before the RRSP contribution deadline (Feb 29, 2008) as it would minimize the interest costs.  Note that the above formula does not account for the loan servicing costs incurred over the few months while waiting for the tax refund.

To further reduce interest costs, consider a 12 month, 0% interest credit card as your RRSP loan.  Basically

Cue geek jokes…

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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michael
8 years ago

With my particular circumstances I too am in need of some solid advice.

40 years old living in Quebec, $45K per year gross with $53 K of unused RSSP space. Calling me a late bloomer is an understatement!

Currently have $4000 in CC debt that is being paid down at $500/month.

I started my own small business this past year, but for various reasons the project was on hiatus until conditions conspired in the last few weeks to move forward.

I am a renter and have never owned. Am looking at purchasing a piece of property in order to house the business and myself. With all my liquidity tied up on paying down that cc as well as a vehicule lease financing agreement of $175/month and renting there is very little left to save towards a down payment on said piece of property and the subsequent build.

So, I am looking at possibly taking out a $25K RSSP loan in 2013 in order to then withdraw as a down payment for a first time home owners (build category). The income tax refund would be 100% applied to the loan, which would be deferred for 6 months so that I can finish paying off the cc debt and release that liquidity to pay the monthly payments in the loan.

Then looking at a $15K loan in 2014, as personal revenu will have gone up to $53K and finally another $15K loan in 2015 as personal revenu is projected to increase to $60K.

I am trying to do my own due diligence on this, as the advice I have been getting from advisors has been mostly along the lines of going for a $40K loan which doesn’t make any financial sense for me.

There are a lot of moving parts here to be added on, but that is the basis of what I am contemplating.

Thoughts?

Ed Rempel
8 years ago

Hi MonsterCable,

My point here is that you are new to investing and your main focus should be on choosing high quality investments. Either do some research and choose good investments or get good advice on investments. Don’t make the focus based on whoever is most convenient or offers a slightly lower loan rate.

Ed

MonsterCable
8 years ago

Thanks so much for all the advice!

One more question if you don’t mind – why is it not advisable to go to my bank to get the RRSP loan?

Is that because I’m putting my eggs into one basket? or for another reason?

Thanks again!

MonsterCable
8 years ago

Thanks so much for replying back so fast FT.

I’m living in NS – does that make a significant difference for your calculations?

I tried applying for a credit line – but the bank said I was carrying too much debt (I also have student loans (6% interest) & a car loan (0% interest)) – I was going to try again for a credit line after Christmas, but was looking around for some advice first.

Do you know (on average) how much the interest rate on an RRSP loan is?

This is all very new to me and I could classify myself as a beginner in investing.

Thanks again.

MonsterCable
8 years ago

Hi,

I too am in need of some good advice.

My income is about $57k and am in my late 20’s. I purchased a business 2-3 years ago and it was like throwing money into the garbage – as soon as I took over everything went to the can. I ended up walking away from it with about $30k in credit card debt (at 11.9% interest).

I’ve currently cut my expenses as much as I can and am paying $1500 towards the credit card debt.

The problem is now I don’t have any savings and putting most of my disposable income into repaying the debt. At the rate I’m going if I continue with $1500/month then I should be debt free in about 2-3 years – but still, no savings and little RRSP.

I talked about this with a Financial advisor and he recommended that by Nov of next year that I should have about $8000 in CC debt left – at that time, I should withdraw an RRSP loan (my current deduction limit for 2012 is $42k).

Does this sound like a good idea?

RJ
9 years ago

I have two questions.
1) will the CRA allow me to take out a RRSP loan to max out my unused contributions against my income this year which is at the highest tax bracket, and then the following year if I’m not working, cash in those same RRSPs at the lowest tax bracket?
2) what is the longest term and amortization period for a RRSP loan?
Thanks in advance! RJ

Penny
10 years ago

Dear FT,
Thanks for putting things into perspective, I appreciate your advice.

Penny
10 years ago

Hi everyone, I could really use some good advice…

My income is approx. 75K am in my mid-30’s, and have been working in Canada for about 6 years. I’m single with no dependants but I’m now at a stage where I’m thinking of buying my first home, however, I have basically no savings. The first 3 years I lived here I had put away some savings and RRSPs but I went to college for a year whilst still working and had to pay my way through the course, so I used up all the savings and have not quite recovered since.

A financial advisor that I know thinks that if I take out an RRSP loan for approx. 20K (I have about 25k room for contribution) and use that borrowed RRSP contribution as a down payment on a house then that would be a good investment of the loan. We’ve also determined that by borrowing that amount my tax return would be approx. 7K, the majority of which I could use to make an initial repayment of the RRSP loan.

I am clueless when it comes to finances so any comments would be appreciated.