Borrow to invest: Is an RRSP loan worth it?

There’s no shortage of competition for your hard-earned money. Whether it’s because of inflation, a mortgage, your kid’s post-secondary education, or an unexpected expense. It’s no wonder saving for retirement often gets pushed aside.

Many Canadians struggle with making regular contributions to their Registered Retirement Savings Plans (RRSPs). They have plenty of RRSP contribution room. They’re just lacking the funds to put in an RRSP.

But there’s a way you can play catch-up: borrowing to invest with an RRSP loan.

What is an RRSP loan?

An RRSP loan allows you to borrow money specifically to contribute to an RRSP. Since it’s a loan, you pay interest on the money you borrow.

Most people take a loan to make an RRSP contribution before the deadline to both:

• maximize contribution room, and
• save on taxes.

What are the benefits of an RRSP loan?

The beauty of an RRSP loan is twofold:

1. It can reduce your tax bill and result in a refund from the Canada Revenue Agency. Then, you can use that money to repay the debt partially or entirely.
2. You can make a bigger RRSP contribution. This can mean more money to compound over the years until you plan to retire.

How does an RRSP loan work?

Let’s look at an example of how an RRSP loan can work. Imagine Caden is a typical Canadian saving for his retirement:

• He’s 35 years old.
• His marginal tax rate is 40%.
• He earmarked $4,500 to contribute to his RRSP this year.
• He borrows $3,000 to add to his intended $4,500 contribution.
• Now, his total refund comes out to the same amount as the loan. ($4,500 + $3,000 = $7,500 x 40% = $3,000). This means:
  • he can pay off the loan right away with minimal interest, and
  • a bigger RRSP contribution means more money to compound over the 30 years until he plans to retire. So, his portfolio could be larger overall.

How do today’s interest rates affect an RRSP loan?

You can generally get an interest rate at or near prime on RRSP loans. Most banks charge their prime rate plus a percentage for an RRSP loan. So, for an RRSP loan to be worth it, your investments need to outpace the interest rate you’re paying the loan.

Rates of return on RRSPs can vary among investments and investment styles. So, if you’re paying 5.45% interest (the current rate at the time of writing) for the loan, but your investments produce more than that, you’ll come out ahead.

When considering financial strategies, some options to explore include:

• investing for the long term (10 or more years) and
• in products that have the potential to achieve a higher rate of return over time than the interest rate of your loan. (i.e. equities).

Otherwise, the interest on the loan could outpace what you make on your investments.

With the rise in interest rates in recent years, the RRSP loan has lost some of its appeal, making it more challenging to surpass the cost of interest through market returns. Moreover, unlike some investment loans, the interest on RRSP loans is not tax-deductible, which further diminishes their attractiveness in the current context.

How long will it take you to pay back an RRSP loan?

When it comes to borrowing and paying back an RRSP loan, most financial institutions:

• let you borrow up to a certain amount for a flexible term (between 1 and 10 years),
• don’t require you to start repaying the RRSP loans for 90 days. (Which likely gives you enough time to get your tax refund), and
• allow you to repay more than your fixed amount at any time (without paying any penalties). This can help you pay off the loan faster and save on interest.

Is an RRSP loan right for you?

An RRSP loan is not the right solution for everyone. Whether you’re a prime candidate for an RRSP loan depends on your:

• age,
• tax bracket and
• ability to pay down debt.

For some, a better idea may be to set up an automatic RRSP contribution plan. This will ensure a portion of your pay is immediately and regularly contributed to your RRSP. Sure, it won’t let you max out your RRSP contribution this year. But it will help you gradually build up your RRSP without going into debt. You also need to make sure the loan payments fit into your budget without hurting your cash flow. If paying down debt is a concern, again, you might want to focus on making regular RRSP contributions instead.