Help my friend in time for the RRSP deadline - Canuck Version
February 25, 2015 5:12 PM   Subscribe

Is an RRSP loan worth it?

Asking for a friend who received a windfall this year and therefore is owing an a lot amount of tax. Suprize!

He has lots of room for RRSP contributions -- at 50 cent dollars about half of the total tax due -- but can only borrow a third of that.

Is an RRSP loan worth it in his situation?

He is in the highest tax bracket, has no other debt, and foresees being able to pay off the loan this year. The primary goal is to get the tax down. He didn't realize until now how much tax he will have to pay and he isn't prepared for it.
posted by OlivesAndTurkishCoffee to Work & Money (6 answers total) 1 user marked this as a favorite
 
Can you clarify what you mean by "windfall"? Is your friend sure that this money is 'income' (i.e. not a gift, insurance settlement, lottery winnings, etc.)? Also, your question implies that your friend had a big income year but doesn't have the cash on hand to just put into his RRSP. Is that the case?

I am not a financial expert of any sort, but I did take a three day retirement course through my work a couple of weeks ago, and the instructor advised us that RRSP loans were essentially never worth it because you are not only having to bet that your RRSP will outperform the interest rate of your loan, but you are also paying off that loan with money that you could otherwise be putting into the RRSP and not paying tax on at all.
posted by just_ducky at 6:14 PM on February 25, 2015 [1 favorite]


Maybe. The answer depends on what your friend's marginal tax rate will be in the future, when he wants to withdraw the money from the RRSP, and the cost of interest on that loan.

Keep in mind that RRSPs don't eliminate taxes, they defer them until you withdraw from the RRSP. If he's in the same tax bracket when he withdraws the funds (unlikely but you never know), he won't be any better off. If he's in a lower tax bracket when he withdraws the money, then it's possible that the tax savings could outweigh the cost of interest on the loan.
posted by ripley_ at 6:22 PM on February 25, 2015 [1 favorite]


Thanks very much ripley_ and just_ducky. All information we really hadn't considered!
posted by OlivesAndTurkishCoffee at 6:30 PM on February 25, 2015


The purpose of RRSP loans is not necessarily this case.

They are more for people who haven't been contributing but have an employment benefit that provides some sort of RRSP match. People sometimes expect bonuses and don't get them. The loan lets them get the match which is a substantial windfall and likely outweighs interest rate costs unless they are negligent on repayment.

However, what to do in this case is a just a math problem. Calculate how much the loan will cost using an amortization table and calculate the tax saved by the loan RRSP contribution. Decide after doing the math. If you want you can factor in the inevitable taxation at retirement but I think that is too far away to really factor in. The compounding return on the invested principle is what matters with an RRSP so deferring the tax is a huge win even if it is just the same sized bill deferred until retirement.

But yeah don't take a loan unless you can get a really low rate and pay it off really fast otherwise you are just digging a deeper and deeper hole each year.
posted by srboisvert at 6:52 PM on February 25, 2015 [1 favorite]


I respectfully disagree with srboivert, most reasons to use an RRSP loan have nothing to do with an employer RRSP match. His description is *one* way of using an RRSP loan to your advantage, but the main reasons are to reduce your tax bracket and (when done properly) create a refund that can either be used to a) help pay down the loan (or other outstanding debts) b) rolled back into more RRSPs c) rolled into something more liquid like a TFSA d) used at your discretion. Often an outstanding debt is paid off with the refund and then what you normally would have paid for the debt is rolled over to more RRSP contributions, with the logic being that the RRSPs offer a better rate of return than the interest on the outstanding debt. The logic is sound, but that isn't to say there isn't a certain level of risk involved.

Of course if the windfall is big enough then it might not lead to a reduction in tax bracket and no return, but then geeze, what did they do with all that money?
posted by furtive at 10:12 PM on February 25, 2015 [1 favorite]


If he can pay off the loan in a year and still be able to make next years RRSP contribution then I'd do it. Don't forget he can use the tax refund to pay off the loan. Article. Also does he have a TFSA? He can pull money from that to contribute to the RRSP too.

The way I look at it, money paid to the government is completely lost. If it costs me $100 in interest to save a few thousand from the government then it's worth it. I am a high earner and I've used an RRSP loan before to cover the shortage but I got a low interest rate (line of credit from the bank, not *really* a loan) and I paid it off in 3 months.

Google around for an RRSP loan calculator to sort out different scenarios.
posted by St. Peepsburg at 4:06 AM on February 26, 2015 [1 favorite]


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