February 18, 2009, 6:00 am

RRSP Loans; A Great Investing Strategy or An Evil Product Manufactured by Banks?

by: The Financial Blogger    Category: Financial Planning,RRSP
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Dring… Dring…

– Hello, may I speak with M. TFB please.

– Yeah that’s me!

– Hello sir, my name is Evil Banker and I would like to book an appointment with you for your RRSP contribution.

– Nah… I don’t have money left for retirement this year (I just bought a brand new TV instead 😉 ).

– Well sir, we still have a solution for you. How about getting your RRSP contribution done and a retirement plan (i.e. excel spreadsheet with a graph) at the same time? We can arrange everything for a small amount per month and you would get a huge tax return in May. How does that sound?

How does that sound? That sounds like the regular banker sales pitch during a RRSP campaign 😉 I’m making fun of my colleague here but we need a bit of laughter in this strange world, don’t we?

Seriously, several Canadians contract a RRSP loan every year in order to catch up with their unused RRSP contribution. Is it a good idea? Should we use this leverage strategy? (yes, it is a leverage strategy as the Smith Manoeuvre).

The RRSP loan is a great investing strategy under the following guidelines:

– It must be at a very low rate of interest (prime rate or near prime rate)

– It must be reimbursed within a maximum of 24 months (2 years).

– It must fit in your budget 😉

– The tax return should be used to pay off a part of the RRSP loan and not to finance the next trip to Disney Land with your kids.

– Once paid off, you should keep your payment into a saving habit by setting up a systematic contribution into your RRSP account.

– Use the RRSP loan while participating to a HBP (Home Buyer Plan)

A RRSP loan is not a great investing strategy under if the following happens:

– You take a huge amount and you can’t pay it off within 24 months. In this situation, you rather simply use the payment as a systematic contribution into your RRSP account and you will save the interest (which is not tax deductible).

– You can barely make your payments and the RRSP loan jeopardize your financial situation.

– You have no intention to use your tax return in a financial planning strategy (you are then missing the whole point of taking a RRSP loan).

So if you are not 100% convinced that you should take a RRSP loan or not, ask your financial adviser questions in order to understand if there is a strategy behind the loan or simply your banker’s commission 😉

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I was almost considering trying out a loan this year since being solicited by ING Direct. They are offering a $25 bonus if you buy $1000 in their street wise fund. They are offering the loans at 4% currently, if I’m remembering correctly. If I simply take the $1000 bucks over a year at 4% and buy the fund the $25 bonus will pay off most of the interest, I get a tax deduction that helps my CCTB next year and gives me a little extra cash back when i do my taxes.

I couldn’t really find the down side to a loan this small that costs near nothing . . . Only a few days to decide 🙂

Over such a short period of time and the bonus, I personnaly think it’s a no brainer ;-0

on top of that, you will probably receive a $300 tax return so you only have to find $700 for the upcoming year 😉

Love the new design TFB by the way, very clean cut!!

Wouldn’t be just better to simply gain some discipline and invest weekly into the RRSP instead of contracting a loan which you might end up doing every year if you start (because it will take away cash flows and thus make it more difficult to contribute weekly?

In my situation, kind of IS. The only other RRSP contributions I make are through my paycheck at work since they match 6% of salary, so 12% of my income gets put away for the future. I doubt that I would make any changes to that.

I suppose it may be better simply to set up a pre-authed payment plan rather than a loan payment, at least that can be canceled in the future if things go awry over the year, you do have a good point there. I’m not sure I’m going to pull the trigger on this one this year, but it is pretty tempting. Knowing the way I act in most other decisions like this i will probably just do nothing until it’s too late, making the decision not to do it for myself through inaction 🙂

thx for the new design 😉

The best way is still to contribute on a systematic basis. However, sometimes it doesn’t hurt to force yourself to become more disciplined 😉

you are already getting 12% out of 18% of your maximum rrsp contribution so you are on the right track. keep it up!

I use an RRSP credit line equal to the tax refund I expect.

For example, if you contributed $5000 throughout the year and was at a 32% marginal tax rate, you could expect a $1600 refund. You could then borrow about $2100 and pay it back with the tax refund.

This can give you an extra year of tax-free growth, force you to invest your tax refund, and even improve your credit rating.

I have not used the strategy yet myself, but as long as you are responsible and like you mentioned use the tax refund for financial planning (paying of part of the loan), i think it is a great option. But unfortunately many who do use it are not fully committed or disciplined.

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