December 3, 2007, 8:00 am

The RRSP Line of Credit

by: The Financial Blogger    Category: RRSP
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We are now approaching December. This mean that you have about three months left to contribute to your RRSP Plan. But what if you don’t have money left for that and you still want to contribute? Well, this is another opportunity where a leverage loan could be useful. Over the year, banks have been very creative with their financial product innovation in order to facilitate borrowing. Today, I am presenting the RRSP line of credit as a recent mean for RRSP contributions.
How does this thing work?

The RRSP line of credit works as any other line of credit. Therefore, it is a revolving account with an authorized limit. The client can withdraw up to the limit and pay it back whenever he wants. The authorized limit is available for him at any time until it is maxed out. The minimum payment required at the end of each month is usually equal to the interest charged on the line of credit or a small percentage of its balance owing (i.e. 3%). The only difference is that the financial institution remains in control of the line of credit disbursements. You will be able to withdraw from this line of credit only to invest the money into a RRSP plan. Most banks will use this product as a marketing tool in order to make you purchase their RRSP eligible mutual funds.

What are the benefits?

The main benefit is that you will not have to meet with your banker every year to contact a RRSP loan. Once the line of credit is in place, it will be available years after years as long as your are paying down the capital owing. You will usually get a good rate as lines of credit offer better lending conditions than loans. A third advantage would be its flexibility. In fact, you are able to borrow money to invest in your RRSP at any time of the year and pay it down with lump sum payments without penalty fees. The fact that only have a minimum payment required each month will ease your budget and you can adapt your payment to your cash flow. It is now easier than ever to adjust your payment once you have used your tax return and apply it to the loan.

What are the down sides?

RRSP loans are offering a differed payments option which allow you to not pay for the first three to six months and start your payment thereafter. Using this feature, you can delay your first payment until you receive your tax return and apply it to the loan. You can then reduce your monthly payment without having done the first one. A RRSP flex line will request monthly (but smaller) payment right after the disbursement. Another negative point was part of its advantages. In fact, the RRSP line of credit flexibility would allow a better cash flow management for responsible individuals but will seriously result into major debt problem for non disciplined people. The temptation is great to leave the balance as is and pay interest only as some people do on their credit cards. Another important note to make is that even though it is a form of leverage, the interest charged on the line of credit is not tax deductible.

The best way to contribute to your RRSP remains the monthly deposit into a RRSP account. However, if you do not have enough money and you can afford an extra payment, then borrowing could be an option.

 

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Comments

Another use (that I’ve used personally) is for big years.

A couple of years ago, I had laser eye surgery (5k in December) and 4k in RRSP contributions on a ~41k income. I precalculated my tax return and then took out a loan for a little less than the amount of the return. (about 2k).

So i effectively “pre-invested” the loan that I knew I was receiving. When the tax return rolled in, I just rolled it over and still had a little cash back at the end. Of course this is only good if you have cash to inject into the RRSP. Which bears the obvious question: “why not just increase your retirement savings instead?”.

In my case, I wasn’t meeting the retirement goals and using the cash back from the eyes (which tends to tie up savings) was a good kick start. Going forward, I’d actually try to avoid using the RRSP LOC and just meet your retirement savings goals, but there are definitely some good exceptions here.

by: The Financial Blogger | December 3rd, 2007 (7:04 pm)

Gates, that’s another great use, that shows the flexibility of the RRSP line of credit.

thanx for your input 😀