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RRSPs RRIFs and TFSAs -> Should I borrow for RRSPs?

Should I Borrow to Contribute to an RRSP?

Dear Old Wise One:

Procrastinate, procrastinate, put off all the work I hate.  That's what I've done.  It's RRSP time again, I've spent all my money, and I don't have anything to put into RRSPs.  For the last 4 years it's been the same story, and my contribution room is getting huge.  I know I should have done my budget 4 years ago when you first told me to.  I'm just too busy, but I have to do something.  I'm getting further and further behind.

I have the desire, but I just don't seem to have the discipline to make monthly contributions to an RRSP, or make a budget.  So, I've gone down to my friendly bank.  They have a great plan for me - borrow $5,000 at 6% interest for 12 months, put it into my RRSPs, and get my tax refund back.  It sounds like I can't lose.  It's forced savings.  It sounds too good to be true!  Is it?

I should mention that I'm 29 years old, live in Ontario, earn $50,000 per year, and I am married with 2 children.  Both my spouse and I work, and we've listened to you and have paid down our high-interest debt.  We only have our mortgage left, and the interest rate is 7%.  I would like to retire when I'm 60, but we don't have company pensions.  What should I do, old wise one?

Sincerely, Procrastinator

Dear Procrastinator:

I've done the math, and put the numbers through my super-de-duper computer, and here's what I've come up with.  Using the 9% return from our Recommended stocks/ETFs for inside or outside of your RRSP article, we have compared the following alternatives, using 2007 tax rates:

Plan #1:  Borrow money from the bank, and use the tax refund to deposit into your RRSP.  Your monthly payments will be $430.33.  The interest on the bank loan is not tax deductible.  With annual income of $50,000 in Ontario, your marginal tax rate is 31.15%.  However, if we include the reduction in the Ontario Health Premium from your contribution, you save $1,708 of tax, or 34.16% of the $5,000.  The savings can be calculated using the Canadian Tax Calculator.

Doing this plan annually, you would have $996,643 in your RRSP in 30 years.  This is a little more money than Plan #2, because you get your RRSP deposit in immediately, and your refund is deposited to your RRSP 3 months later.  This is the power of compounding interest.  The problem is, you have to go to the bank to get a loan every year.

Plan #2:  Don't borrow money, but use the loan payment calculated in Plan #1 plus tax savings as a monthly deposit to RRSPs.  Thus, if you have a $430.33 loan payment and 34.16% tax savings, you would make a monthly deposit of $577.33 ($430.33 + (34.16% x $430.33)) to your RRSP.  Do this as an automatic payroll transfer to your RRSP, and the income tax will be automatically reduced.  Once you set this up, there is nothing else to do unless you change employers.

With this plan, you would have $989,770 in your RRSP in 30 years.

Plan #3:  Don't borrow money, use the loan payment calculated in Plan #1 as a monthly deposit to RRSPs.  Use the tax savings or refund for living expenses.  Set up and forget, as with Plan #2.

With this plan, you would have $737,753 in your RRSP in 30 years.  It is significantly less than plans #1 and #2, because the tax savings are not going into your RRSP.

Plan #4:  Borrow money from the bank,  and use the tax refund to pay down the loan.  Off to the bank every year, as with Plan #1.

With this plan, you would have $742,876 in your RRSP 30 years.

All four of the above plans are good, because you are putting money into RRSPs.  You can go to our Borrow for RRSPs Calculator, put in your numbers (including your current marginal income tax rate), and work out your own plan.  We recommend using Plan 2, but increasing your RRSP contribution to 15% of your gross earnings (see pay yourself first).  It is the simplest to do, it is less likely anything will go wrong, and it is a little better for dollar cost averaging.  With this plan, you would have $1,071,488 in your RRSP in 30 years.  One drawback is that you will probably only want to make a stock purchase every few months in order to minimize your commission costs.  This will slightly reduce the returns calculated above.  Since you have paid down all your high interest debt, we recommend that you go to your employer and get them to automatically transfer your "pay yourself first" money to your RRSP.    If your employer can't do this, get your financial institution to make automatic transfers to your RRSP.

Sincerely, Old Wise One

Tax Tip:  Before you put money into RRSPs, make sure you can pay off your mortgage before your children enter university.

Should I borrow more?

Dear Old Wise One:

Since the plan to borrow $5,000 to put money into RRSPs looked pretty good, should I borrow $50,000, put it in my RRSP, and pay it off over 10 years?

Sincerely, Procrastinator

Dear Procrastinator:

Theoretically, you will be further ahead because you are getting your money into your RRSP sooner, but there are some major drawbacks to this plan.

There are two alternatives to this plan - let's call them Plan 5 and Plan 6, to continue on with our above analysis.

Plan 5:  Borrow $50,000 to contribute to your RRSP, and put the tax refund into your RRSP.

You can't use all of the contribution in one year.  To maximize your tax savings, you would use $36,000 of the contribution in the first year, and $14,000 in the second year.  Your total tax savings would be $9,840 plus $4,584, or $14,424 over 2 years (use the Canadian Tax Calculator to determine your savings).  This is 28.8% of your contribution.

To keep your payments the same as with the $5,000 loan you would have to pay back your loan over a period of 14.5 years.  This means your next contribution would be made in 15 years, taking out another loan.

With this plan, you would have $1,083,020 in your RRSP in 30 years, more than with Plans 1 to 4.  However, you have a large outstanding debt which could be a major problem if anything goes wrong.

Plan 6:  Borrow $50,000 to contribute to your RRSP, and use the tax refund to reduce your loan balance.  This will mean your loan can be paid off in just over 9 years, so you could repeat this process in 10 years and again in 20 years.

With this plan you would have $1,061,972 in your RRSP in 30 years, more than with Plans 1 to 4.

We don't recommend either Plan 5 or 6 because:

bullet it is not a good idea to put such a large amount of money into stocks all at once.  It is better to dollar cost average your purchases to reduce your risk.  Plans 2 and 3 are the best for dollar cost averaging, and Plans 1 and 4 aren't bad.
bullet the large outstanding loan could be a problem in the event of job loss or extended sickness, or if you have a financial emergency.  You are still making mortgage payments, so increasing your debt by this much is probably a poor idea.

Our recommendation is still to use your pay yourself first money to contribute to an RRSP, through automatic payroll transfers in order to have your income tax reduced immediately.  You will not have a large outstanding loan, and in case of financial emergency you could temporarily stop these transfers.

With all six of these plans, you are still not using your available contribution room, which is getting larger and larger, because you can contribute $9,000 per year and you are only contributing $5,000 per year.  But don't worry.  If you stick to one of these plans (1 to 4) you are on the right track.  You have other things to spend your money on, such as paying down your mortgage and raising your children.  Once your mortgage is paid off, you will have more money for either RRSPs or your children's education.  Once your children are finished with their education, you will find that your wages have probably increased and you have lower expenses.  This is a good time to catch up on your RRSP contribution room.  If your spouse also uses one of these plans, you should have no problem retiring when you are 60.

Sincerely, Old Wise One

Every province and territory has different tax rates, and each person's situation differs.  Use our calculators to compare different scenarios.

If you are planning to borrow to contribute to RRSPs, check out our Borrow for RRSP Calculator.

Tax Tips:

Pay yourself first.

Use payroll deductions to contribute to your RRSP, instead of borrowing.

If you're in the lowest tax bracket, invest in TFSAs before RRSPs.

If you have never invested, don't start by borrowing for RRSPs!

Revised: October 26, 2023


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