It might sound rather funny to borrow money to save money, but that’s the general idea behind an RRSP loan.
When the RRSP deadline approaches, some Canadians will take out an RRSP loan to make a large contribution before the deadline, which will hopefully result in big tax savings in the short term.
Most Canadians use RRSP loans to catch up on contributions they wanted to make, but never stick to their monthly contribution plan.
How does an RRSP loan work?
You borrow a lump sum of money and have to make principal and interest repayments regularly over a period of time. The only thing that makes it an RRSP loan is that the lump sum goes directly into your RRSP account.
RRSP loans repayment schedule could be from 1 to 10 years. They often include a defferal on when the first payment has to be made, too. For example, if you take out an RRSP loan in February you might have the option of not making the first payment until three months later. Why would you do that? Because it might give you enough time to file your taxes, claim the RRSP contribution, and generate a tax refund. That refund could be used to reduce the loan balance and, depending on the loan provider, give you the option of an lower monthly payment than originally planned.
What are the benefits of an RRSP loan?
The benefits of an RRSP loan leads people to getting an RRSP loan every single year. Also, you should be aware that there is a cost to borrowing money which offsets some of the potential gains from investing.
Usually, interest rates on RRSP loans are low. If you feel tempted to take out an RRSP loan every year because you feel that’s what keeps your overall contributions higher, just remember that if you’re making an automatic loan payment or making an automatic contribution, there’s not much difference, except one comes with interest chargers.
Here are a few situations where an rRSP loan looks more attractive:
1. You’re in a high tax bracket
The higher the tax bracket, the bigger your refund. That’s a powerful motivator. Just make sure to put your refund to good use and not for conspicuous consumption.
2. It would use most of your cashflow
All of this legacy building plan assumes that you already have life insurance in place. If you don’t, the time may be right for planning ahead and to obtain a life insurance policy. Remember, not only will your tax-free funds be used to help take care of your funeral cost, outstanding debt, taxes payable, etc., but you will also make a difference in a cause or charity of your choice while allowing your name to live on for many years to come.
3. You’re only using a short loan
You should be able to pay off the loan quickly. As a result, it will minimize the interest you’ll have to pay.
Some people might start a plan where they would commit to a monthly contributions, but stop because of other financial commitments. Committing to a one year RRSP loan is more likely to result in hitting your goals for fear of missing a loan payment. On the other hand, if you are able to make the RRSP loan payments, you probably can set up a regular RRSP contributions that wil save you money on interest payable.