If you’re thinking of borrowing to invest in your RRSP, think about it very clearly and realistically. A few financial planners we interviewed weren’t set on using the approach – but were willing to go along with it on a few conditions.
“I’m not a fervent practitioner of it,” says Fabien Major, financial planner with Équipe Major, in Montreal. “Too many people drag their loan for too long, and it becomes a weight.” John Lawson, senior wealth advisor at Sana Family Office, in Surrey B.C., is more amenable to the idea. “But I prefer regular contributions, he says, in order for the investor to remain ahead of the game. Sometimes, it makes mathematical sense, but most times it’s just a sign of bad planning.”
Gears of a loan
Here’s the mechanics of an RRSP loan. Let’s say you want to invest $5,000 and take a loan for that full amount. The key lies in getting an RRSP credit from both levels of government. Let’s say your tax bracket is 40%, after filing your tax return you will get $2,000. That credit gives you an investment power of $5,000 for a cost of $3,000. So it can be interesting to borrow to benefit from that investment potential.
It is imperative, according to the advisors, to reimburse the totality of your loan within the year, otherwise “you carry an extra loan burden and I find that it’s just too much,” says Major. Take the $2,000 tax credit and apply it against your loan, leaving a balance of $3,000. IF you can afford the payments to reimburse that outstanding amount within the year, only then proceed.
If not, hold back, because if you carry your debt into the new fiscal year, you will be eating into the money available for a new RRSP contribution for that year.
Jackie Porter at Carte Wealth Management suggests a couple of scenarios where it makes sense to take a loan to invest in your RRSP – if you have high interest (i.e. double digit) debt, and use the loan to pay off the debt, and if you are a higher income earner who has not maximised contributions.
Pay off debt
Individual investor William Caire never borrows for his RRSP contribution, but he made an exception for his girlfriend when they moved in together to help pay off her credit card debt.
William suggested his girlfriend Sophie borrow the full amount of an RRSP contribution of $5000. Sophie then had to consider any incentives based on their provincial tax residence. As Sophie was in Québec, she opted to put that money in the labour-sponsored Fondaction fund, and got an additional tax credit of 40% over the government credits, which gave her a total return of approximately $3,500. In this case, Sophie was dragging a credit card debt of $2,000, at 19.9% interest; so William had her clean that away and used the remaining 1,500$ to cover part of the $5,000. And he made sure to pay the outstanding $3,500 debt within the year.
Be aware of one thing, cautions Caire: “If you invest in a bank’s RRSP fund, that bank will give you a favourable RRSP loan carrying interest at 5% or 6%, he notes. But if you buy an outside fund like we did with the Fondaction fund, the bank will only allow you a ‘personal loan”, and that will carry an interest charge of 10% to 11%.” Keep in mind that incentives – and returns – of sponsored funds vary considerably by province.
Keep and eye on returns
Caire says that he is satisfied with the return of Fondaction, and at face value, his confidence seems quite justified. On its website, once tax credits are integrated, the fund boasts a 10-year return of 13.4%, but it doesn’t specify what that holds for in a range of tax credits varying between 30%, 35% and 40%. Of course, for an investor outside Québec, those generous extra provincial credits are not accessible, only those at the federal tax level.
In other provinces, funds of this type often have much lower returns and not as generous tax credits. Also, Lawson notes, “these are high-risk venture capital-type funds. You need to have the stomach for it. And remember that we’ve had a number of these funds in BC that have been dissolved.”
One must have realistic return expectations. If you think that a 12% return will keep you ahead of the interest charged on a loan, think again. Some investments can give you that, but it’s unrealistic to plan on it; you could also end up with a -12% return. Keep your eye on the long term and avoid investing in things too volatile
Getting a revenue boost
“If you are a tax resident of Ontario, earning between $48,536 and $78,783, for every dollar you invest in an RSP you would get 30 cents back,” says Porter. “Contrast this with the person who earns over $220,000. For every dollar they invest they would get 54 cents back - which could be very compelling - especially if they are staring down high-interest debt and need to save for retirement.”
An RRSP loan can be used for strategic advantage, adds Lawson. For example, he continues, an investor who has a large unused RRSP contribution space could invest $50,000 and cover that with a loan of equal size, which he would reimburse as soon as he receives his extra income.
Such a one-time income hike could be used to maximize a young couple’s call on a Home Buyer’s Plan (HPB). “If both partners are in a 40% tax bracket, Major explains, they could each borrow $20,000. Add in a combined tax credit return of $16,000, that means they could crank up their HPB disposable capital to $56,000. Without a loan, they would probably be able to put in only 20,000$ or $30,000 for their HPB. But they can do that only if they’re sure of getting that extra income shot to pay off their loan.”
Finally, it all depends on your personal situation. Porter suggests asking the tough questions, including why are you considering this? What are your other available options? What is your income? And financial circumstances? How long will you be financing the loan? Can you afford to make the loan payments and have a financial cushion should your circumstances change?
Are you getting the right return on your investments?
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