Money & Career

Should you take out a loan to contribute to your RRSP?

Author: Canadian Living

Money & Career

Should you take out a loan to contribute to your RRSP?

You've had good intentions all year to set money aside to make that all-important RRSP contribution come March 1. But household bills, credit-card debt and plain old procrastination have sabotaged your plans. You simply don't have a lump sum of cash sitting in your bank account that you can transfer into your RRSP. Should you forgo your contribution this year and make a fresh commitment to be more diligent about saving next year? Or should you borrow the dough from the bank so you won't miss out on the opportunity to add to your retirement nest egg this year? Chris Brown, an associate financial planner with GP Wealth Management in Toronto, examines the pros and cons of borrowing to contribute to your RRSP.

Pros
You'll pay less tax: An RRSP is one of the best tax shelters available to Canadians, since it allows your investment income to grow tax-free and any contribution you make is deducted directly from your income. For example, if you earn $50,000 a year and contribute $5,000 to an RRSP, you'll only have to pay income tax on $45,000.

Enforced savings: "Borrowing to make an RRSP contribution works well for individuals who don't have the discipline to save on a regular basis," says Brown. You may have difficulty setting aside savings, but it's less likely you'll risk skipping a loan payment.

Low rates and easy terms:
Interest rates for RRSP loans are as low as prime (2.25 per cent at press time) plus 1 per cent. And the banks will often defer your first monthly payment until you get your tax refund.

Play catch-up: If you have lots of unused contribution room in your RRSP, borrowing allows you to top up your contributions and take full advantage of the tax benefits.

Page 1 of 2 - Find out the cons of taking out a loan to contribute to your RRSP on page 2.

Cons
It's another debt: If you already have trouble making ends meet, another payment to contend with each month may result in a cash-flow crunch. "Remember, if you can't make your loan payment, you can run into credit problems," says Brown, who also suggests checking exactly what your monthly payments will be before taking out the loan and immediately applying your tax refund to the loan, which will reduce its amortization time.

It'll cost you: Although interest rates are low, you'll still pay for the privilege of borrowing cash for your RRSP. Banks will usually defer interest on an RRSP loan by 60 to 90 days but interest begins accumulating as soon as you take out the loan.

You can't deduct the interest:
Money borrowed to earn non-registered investment income is tax deductible, but interest on a loan for your RRSP is not. If you have cash to invest, put it in your RRSP and borrow for outside investments so you'll get the tax deduction.

If you're hesitant about taking out an RRSP loan, Brown advises investors to remember that there's such a thing as "good" debt and "bad" debt – and an RRSP loan falls into the category of good debt. "That's because you are using the money to facilitate retirement planning, lower taxable income and have tax-deferred growth," he says.

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