This week, Enrique writes to us: “I am 45 years old, little debt, except my car loan and my mortgage. With the increase in the cost of living, I ended my RRSP investments in recent months. Would it be advantageous to use the RRSP loan between now and February 29? »
In January, it is almost certain that questions about the relevance of borrowing to contribute to an RRSP will arise. Certainly, last year, the surprise caused by the sharp increase in interest rates applicable to this type of loan dampened the enthusiasm of many. But seeing that rates, even if they decrease, are expected to remain high, investors who have fallen behind in their contributions will perhaps start to take an interest in RRSP loans again. Is right.
I will resist the temptation to submit to you dry calculations of loan profitability. Since there are as many potential calculations as there are personal situations, it will be much more relevant to do your own calculations with the help of the professional who knows your situation. Nevertheless, it is good to know that there are situations where the RRSP loan can be useful, despite a high borrowing cost, that you should know about.
You have not made enough installment payments. Self-employed workers, or shareholders of a private company who are remunerated by dividend (in whole or in part), must generally pay installments, both to Revenu Québec and to the Canada Revenue Agency. If your net taxable income has increased as a self-employed worker in 2023, your advance payments may therefore be insufficient to cover the taxes payable at the time of submission of the tax return.
Furthermore, if you are in your first year and no deposit has been made, the same window of opportunity for the RRSP loan could open up for you. For example, if you estimate that you will have to pay $25,000 in taxes on April 30, borrowing it to contribute to the RRSP could reduce this bill significantly. However, this assumes that you have planned well to manage your liquidity and that you can therefore assume the balance of your remaining tax debt and the repayment of the loan.
At least you will have invested for retirement rather than only having to pay a balance to the tax authorities next spring. The game is worth the candle. Get out the calculators or consult your experts.
You have already contributed to your RRSP in 2023. Let’s say you’ve already contributed $10,000 to your RRSP. At a marginal tax rate of 40%, you can therefore expect a tax refund of $4,000. It would therefore be entirely acceptable to borrow this same estimated repayment amount in the short term in order to contribute more to the RRSP and thus make up for unused rights.
While any amount invested for retirement is worthwhile, it is important to consider marginal effective tax rates in your personal analysis. Sometimes a small additional contribution amount can strategically reduce the income from which certain credits and programs are calculated. If you receive family allowances, for example, these will be higher after the additional reduction made possible thanks to the RRSP loan. Even with an interest rate of 7.7%, the cost of borrowing will be limited between the borrowing period (February) and repayment in April.
You have the ability to repay your loan AND contribute for the future simultaneously. Notwithstanding the fact that interest charges must be included in the calculation of the profitability of the RRSP contribution, it is also appropriate to discuss more global planning. Remember the fact that you will spend the next few months repaying a loan for a fiscal year that has already ended. And ideally, you will still have to contribute for the current year.
Contrary to what you might think, even if you use part of the tax refund in the spring to reduce the balance of your loan, the monthly payments established in the loan contract generally cannot be reduced. The best advice remains that of having an established financial plan that allows you to invest regularly in order to facilitate your liquidity management in the long term.
But if you are ready to show discipline or your income allows you to do these two things at the same time, the RRSP loan is ideal for making up for unused rights.
Traps to avoid. Obviously, if you had planned to use your tax refund to repay an RRSP loan with a high interest rate and you use this capital to go to the South, the strategy practically loses all its meaning (financial, at least). The RRSP loan is therefore not recommended if you have the cicada rather than the ant profile. Budgetary discipline is essential.
Finally, some institutions offer loans with a really long repayment period. Unless you make a massive catch-up on unused rights, a very short repayment period increases the profitability of the strategy and the likelihood that you will eventually move to an RRSP contribution plan that does not require borrowing.
In all cases, I generally recommend the RRSP loan strategy for investors whose investment horizon is longer and whose risk tolerance allows them to invest in the markets rather than aim for guaranteed products. Otherwise, a more in-depth and personalized analysis should be carried out with a professional to confirm that the projected low yield, combined with the cost of borrowing, still justifies the tax strategy.