Me and My Money

RRSP Borrowing

Posted November 25, 2011
Originally Published July 18, 2011

Is it a good idea to borrow for RRSP contributions? No! Never! Don’t do it!

On the other hand, consider Serena. She is 30 years old and earning $41,000 a year. To date she’s paid off all but $4300 of a $40,000 student loan and anticipates the balance will be zero six months hence. That feat alone is worthy of note. But there’s more. “I've loaned my parents $15,000. At the end of the year, they will be in position to pay me back. I was thinking of using that money to buy RRSPs. Additionally, I want to borrow $5,000 (at 2.5 per cent) to buy another $5,000 in RRSPs. I have enough carry over (contribution room) to buy $20,000.”

If Serena follows her plan, she anticipates a refund of $6,000 on her 2010 taxes and intends to use it to pay off the RRSP loan. “This would essentially turn my $15,000 into $20,000 in RRSPs,” she writes. “Does this sound too good to be true?”

Actually Serena, you sound too good to be true. Still, if you didn’t have parents already I’d adopt you.

First of all, a quibble about language. It’s important to realize that you don’t buy RRSPs; you contribute to them – like putting money in a box. Then you (usually) purchase an investment product of some sort from GICs to mutual funds or individual stocks and bonds.

I can tell right off the bat that Serena is a very cautious person with her money. She paid off a large student loan in a fairly short period of time, even though she’s not earning a large income. And somehow she’s managed to find $15,000 to lend to her parents (my adoption offer still stands.)

Serena’s nature dictates that she should also be very cautious about making what is usually a risky proposition, borrowing for RRSP contributions.

Generally, I’m death on the strategy, because I’ve rarely seen it work. The idea is that you borrow money to make an RRSP contribution, use the ensuing tax refund to pay of the bulk of the borrowing, all the while your RRSP investments are earning more than the interest costs.

The sticking point is that most people don’t follow through with repayment. As a result, the borrowing is added to the overall debt load and the tax refund gets frittered away on something else. After all, if you aren’t disciplined enough to put money aside in the first place, chances are you won’t be disciplined in paying back the loan.

But Serena has already demonstrated determination and discipline. Still, I’d suggest she makes sure to pay off the student loan before she embarks on the next stage of her plan. It’s always hard to juggle more than one debt ball.

The other issue with RRSP loans is that the temptation is greatest when the market is hopping hot. Those who borrowed to contribute in 2007 may still be underwater with their investments despite the recent market revitalization.

Serena’s plan is well thought out but she confesses, “I’m stumped, or maybe scared.” That may be because she doesn’t know much about her RRSP box or what to do with the money she contributes. Fortunately, the second part of her plan dictates her investment options. “I plan on borrowing from my RRSP to buy my first condo using the Home Buyers’ Plan in the next 2 years.”

Aha! The condo purchase is short term and that means Serena shouldn’t invest the money in the stock market in any form, including equity mutual funds, stocks or equity exchange traded funds. Instead, she should keep the money liquid. Since she’ll have a lump sum, a 6-month GIC will earn a little interest and be safe as houses (err, condos.) When the GIC comes due, interest rates might have risen and it can be rolled over into a new one.

Borrowing $5,000 for an RRSP contribution is fairly low risk in this situation. But I believe in following the dictates of one’s innards. If the idea churns the stomach, don’t do it. Serena isn’t going to make wads of dough on that $5,000 and when her student loan is paid off she can simply devote those funds to regular RRSP contributions. In short order she will have that $5,000 additional in her RRSP without the loan.

I have one other word of advice to Serena. Once she has achieved her $20,000 goal, she should direct some savings into a TFSA (tax free savings account.) New homebuyers can be derailed financially with unforeseen costs associated with their first purchase.

Good luck Serena!

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