We are in the middle of the RRSP season and I am pretty sure that your financial advisor already called you for your contribution. You don’t have the money to contribute to your RRSP this year? Since it’s very important to prepare for your retirement and we take your financial situation to heart, we are going to offer you an RRSP loan. I Call BS on this one!
Why taking out an RRSP loan is bad for you
There is actually one specific strategy where the RRSP loan is good: when you are about to buy a property. I’ll cover that later on. But for now, get this straight in your mind: RRSP loans are only good for the bank, NOT YOU!
Why? Fundamental mathematics will show you why J
Let’s say you take out a $10,000 RRSP loan with an amortization of 5 years. For the sake of calculation, let’s assume your RRSP loan is at a very good rate of 6.5% for 5 years (fixed rate). If you pay monthly, your RRSP loan payment will equal to $195.66.
If you invest this money and make a 6% yield, you will have $13,382 in your investment account after 5 years. However, if you setup a periodic investment of $195.66 per month during 5 years and make the same 6%… you will end-up with $13,651. I agree that this is not a huge difference, but if you take out an RRSP loan every 5 years instead of investing regularly during the next 25 years, then you get:
RRSP loan every 5 years: $130,246
Periodic investment: $135,591
There is more about the RRSP loan:
If you take out a 10K RRSP loan, you will invest this money in one shot. Over the long run, it won’t make a big difference but you might bit your nails at first if you start investing right before a crash. Just think of people who did this strategy back in 2008! If you make preauthorized investments, you will be able to average the cost of your investments which will smooth out any dip in the market.
The last point is the amount of RRSP contribution vs your marginal tax rate. If you are right over a tax bracket and take a big loan of 10K, you will get a smaller tax return than if you add your 5 years of smaller contributions. You must take a look at your marginal tax rate to know if this advice is good for you or not.
RRSP loans can be good if…
If you plan to buy your first house this summer and you are thinking of using the HBP. You can take an RRSP loan, get a bigger tax return and withdraw your investment to pay off your loan under the HBP. Then, you won’t have an RRSP loan anymore but you will have benefitted from a tax return to boost your cash down. This could be an interesting strategy (just remember that you must keep your investment within the RRSP account for at least 90 days before withdrawing them under the HBP!).
If you take an RRSP loan over a short period of time (12 to 24 months), then it will be worth it. Chances are that the interest paid on the loan will be minimal and if you are lucky enough, you will benefit from a gain on the stock market.
You want a clear answer on RRSP loans? Ask your advisor!
If after reading this column you are confused about whether or not you should take a RRSP loan, ask your financial advisor to make both calculations:
A) What is going to happen to my investment over the next X years if I take a loan?
B) How much would I get if I take the payment loan amount and invest on a monthly basis with it?
Remember, people may lie… numbers don’t 😉
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