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If you’re like most Canadians, your RRSP eligible investments will likely be a vital source of retirement income. However, like most Canadians, you’re probably not making the most of your contribution room. According to Statistics Canada, in 2010, almost 93 per cent of taxfilers were eligible to contribute to RRSP eligible investments, but only 26 per cent actually made contributions, adding up to $33.9 billion in total contributions – but representing only 5.1 per cent of the total room available.*
If you’re having trouble coming up with enough money to fill your available RRSP eligible investments contribution room this year or if you’ve got unused room from previous years, an RRSP loan may be a smart strategy.
RRSP eligible investments can provide solid tax savings along with tax-deferred, compound growth so the short-term interest costs of an RRSP loan can be outweighed by the long-term benefits. Here’s an example **:
You’re entitled to make a maximum contribution to your RRSP eligible investments of $10,000 for the 2012 tax year but you have only $5,000 of cash on hand. So, you borrow the additional $5,000 (at seven per cent interest) and – here’s the important part – pay it back in a year.
If your marginal tax rate is 35 per cent, your additional $5,000 contribution gets you an immediate tax refund of $1,750 and (at an annual return of eight per cent) your $5,000 top-up loan earns an additional $400 at an interest cost of $190 for the loan.
If you leave the additional $5,000 in your RRSP eligible investments for 25 years, that top-up contribution will grow to more than $34,000 (at an average rate of eight per cent).
The keys to ensuring you have a successful top-up RRSP loan strategy include:
Getting a low interest rate that does not eat up your potential tax savings and investment returns;
Repaying the loan as quickly as possible – preferably in one year but, in most circumstances, no longer than two years;
And using your RRSP-related tax return to pay down your loan.
Consider using the cashflow from a Pre-Authorized Contribution (PAC) program to fund your RRSP loan payments. Depending on the interest rates, using PAC income can help you by, for example, avoiding cash crunches that might prevent loan payments.
An RRSP loan is not the right strategy for everyone. Your professional advisor can help you make that decision as well as how to make the most of your investment savings for retirement.
Borrowing to invest involves risk and may not be suitable in all situations. Speak to an Investors Group Consultant to see if this strategy is suitable for you.
* Statistics Canada, The Daily, Friday, December 2, 2011, statcan.gc.ca/daily-quotidien/111202/dq111202b-eng.htm
** The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values or returns on investment.
This column, written and published by Investors Group Financial Services Inc. (in Québec – a Financial Services Firm), and Investors Group Securities Inc. (in Québec, a firm in Financial Planning) presents general information only and is not a solicitation to buy or sell any investments. Contact your own advisor for specific advice about your circumstances.