Here’s how borrowing to contribute to your RRSP (in the biz world it’s called leveraging), is supposed to work. You take out a loan, make the contribution, get a tax deduction and, hopefully, a refund. You repay the loan, the investments grow and you live happily ever after.
It’s a great idea, on paper. In reality, I rarely see it work because people invariably fail to look at their own behaviour. If you haven’t been able to make the RRSP contributions throughout the year, how are you going to pay back the loan?
I’m not ruling out borrowing for your RRSP contributions — but only if you can say yes to these five ifs.
If you have a taxable income
You’d be shocked how often those with contribution room, but no taxable income, contemplate borrowing to deposit money in their RRSP.
Obviously, the higher your marginal tax rate, the better the strategy looks. But don’t forget that interest on money borrowed to contribute to an RRSP is not tax deductible.
If you don’t have high interest, non-mortgage debt
It makes absolutely no sense to borrow money for a RRSP when you’re already paying high rates on credit card debt, usually between 12 and 19 per cent, or on retail card balances, which can get as high as 29.9 per cent.
If you’re disciplined enough to take the tax refund and slap it on the loan
If you can pay back the loan quickly. Most in the financial industry suggest aiming for a year, maximum, to discharge the debt, and I agree. By not paying it off within a year you risk making it a permanent part of your debt load.
If you can invest the money wisely
There’s nothing more disheartening than borrowing to contribute to your RRSP, then seeing that money shrink by 20 or 30 per cent because of stock market losses.