The Registered Retirement Savings Plan (RRSP) is one of the most powerful tax-sheltered investment accounts available to Canadians. The only way to make use of its power to lower your income taxes and boost your retirement security is to make contributions. But how do you do that if money is tight?
How does an RRSP loan work?
An RRSP loan can be a valuable tool to increase your retirement savings and lower your income tax bill simultaneously.
Many high-income earners can greatly benefit from RRSP contributions to lower their income tax bill. However, if you had other financial obligations over the past year that left you with little cash left over to save and invest, you might find you don’t have the money on hand to make an RRSP contribution.
In this situation, it could make sense to borrow money via an RRSP loan to make an RRSP contribution. Then you can claim your RRSP contribution when you file your income taxes to receive a tax refund. You then use the tax refund to pay down your RRSP loan. The result is a net worth increase simply from moving money around!
Your income tax refund is unlikely to be enough to wipe out the entire debt of your RRSP loan, but it should make a significant dent in it. This makes it easier to pay off the debt quite quickly, while the investment in your RRSP grows.
RRSP loan pros & cons
Like all financial products, there are pros and cons to RRSP loans. Here are some things to consider before borrowing:
RRSP loan pros
- help you to make an RRSP contribution you wouldn’t otherwise be able to
- reduce your income tax bill
- typically very low interest
- a “forced savings plan” for those who might find it difficult to save but always pay off debt
- allows you to make a lump sum investment in the stock market in your RRSP at the beginning of the year, instead of small contributions throughout the year
RRSP loan cons
- have a debt you will need to pay off in 12 months or less
- not useful for those with low marginal tax rates and/or incomes below $100,000
How long do you have to pay back an RRSP loan?
You will have 12 months to pay back an RRSP loan.
But most RRSP loans are open-ended, which means you can pay them off sooner. One of the best ways to pay off an RRSP loan is to use the income tax refund you receive from RRSP contributions.
Can you claim interest on an RRSP loan?
Unfortunately, RRSP loan interest is not tax deductible.
However, the interest rate on RRSP loans is typically fairly low. Expect to see interest rates on RRSP loans ranging from 3% to 4%.
What is the maximum you can borrow with an RRSP loan?
The maximum a lender will provide for an RRSP loan is $50,000. This is more than the annual maximum RRSP contribution, so it is enough for a high income earner to catch up on the entire past year of contributions plus unused room.
How much you will be offered from your bank for an RRSP loan depends on your income, credit history, and credit score. Most people will receive RRSP loan offers for $5,000 to $20,000.
Using an RRSP loan for a house downpayment
For many aspiring home owners, an RRSP loan can be a quick way to help build their downpayment fund.
You can borrow up to $35,000 from your RRSP under the First Time Home Buyer’s Plan. However, if you’re going to borrow money from your RRSP for a downpayment, you have to have money in your RRSP first!
An RRSP loan can be a great way to quickly fund your downpayment under the HBP. Just remember that taking out an RRSP loan adds a debt to your balance sheet, and that debt will come up in your mortgage applications. Make sure you can pay off enough of the RRSP loan before you start house shopping so it does not prevent you from qualifying for a mortgage.
Who should take an RRSP loan?
RRSP loans work best for high-income earners with a marginal tax rate greater than 30%. The higher your income and the more taxes you pay, the more beneficial it can be to take out an RRSP loan.
Borrowers with marginal tax rates over 30% have the most to gain from RRSP contributions reducing their income tax burden, as well as the income to manage paying off the loan.
If your income is below $100,000 per year or your marginal tax rate is less than 30%, it’s unlikely you will benefit in significantly reducing your income taxes with an RRSP loan. You’re better off waiting until your income and your tax bill is higher.