3 RRSP myths

2. Borrow if you don't have the funds
"Don't have the cash for an RRSP contribution? No problem. We'll lend you the money!"

You can hear that offer every February. Here's why you shouldn't listen to it.

Borrowing to invest makes sense in the long term only if the rate of return exceeds the interest rate on the loan. Obviously, it doesn't make sense to borrow at five per cent to invest in a term deposit making only 2 per cent! If you do borrow to invest, you are essentially agreeing to put all your eggs in one basket -- the stock market -- and hoping that it beats the rate on your loan. Once again, this strategy play directly into the hands of those people who make a living off your finances.

3. Invest in an RRSP before paying down the mortgage
This question of whether or not it's wise to invest in an RRSP before paying off the mortgage also comes up every year. The usual answer is that you should contribute the maximum to your RRSP and use the tax refund to pay down your mortgage. Sounds like a good compromise, doesn't it? This way, the finance company gets your investment money and it's up to you to be disciplined enough to actually use the refund to pay down your mortgage. Of course, that's easier said than done.

First of all, you need to be able to afford to pay down your mortgage. In other words, you mustn't need the refund for anything else, such as paying down other debt or taking a much-needed vacation. Second, usually you can only pay down a mortgage when the finance company allows you to. Often that's only once a year and is limited to 15 to 20 per cent of the outstanding balance. You have to be very disciplined and make sure you put the refund into a safe place until then.

The reality is that investing in an RRSP and using the tax refund to pay down the mortgage is usually not a compromise at all. The people who send this message are, in fact, simply wanting you to invest in an RRSP. Period. I am saying pay down the mortgage instead. Period.

Another problem with RRSPs
What happens if you are heavily invested in stocks when you are about to retire? What about the thousands of other baby boomers in the same situation? Lots of Canadians are going to be forced to sell their stocks and mutual funds to fund their retirements. Some will start earlier, and some will be able to afford to delay withdrawing money until age 70, when they must begin making the minimum RRIF withdrawals. What will that do to the stock market? No one knows for sure, but if more people are selling than buying, its most likely direction is down.

This will be happening at the worst time possible -- when there is no time left to correct it and when no employment income can be earned to replace it. You may want to consider reducing your exposure to this risk, and that means reducing your investments in stocks and equity mutual funds.

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Excerpted from Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams by David Trahair, CA. Copyright 2004, 2007 by International Self-Counsel Press Ltd. Excerpted with permission of Self-Counsel Press. All rights reserved. No part of this excerpt may be reproduced except with permission in writing from the publisher.