March 1 is the RRSP deadline. Every year financial advisors send out metric tonnes of paper advising customers to buy-buy-buy.
And if you don’t have the cash they will be very happy to assist you with securing an RRSP loan.
But is an RRSP loan the best idea?
The arguments in favour tout the instant tax reduction, the benefits of kick starting long-term growth and the positives of a healthy retirement nest egg.
The downside of RRSP loans? First you are borrowing money. Most RRSP loans have a one year repayment schedule, although you can get 2 or 3 year terms. That means you are adding on a monthly payment you may or may not be able to afford. If you could afford it why aren’t you already depositing that amount in your RRSP account?
The lender doesn’t care. If you don’t make your payments the lender will just cash out the RRSPs to repay the loan. And Canada Revenue Agency will make sure that they get repaid any taxes they refunded you.
So why are financial advisors so hot to push RRSP loans? Two reasons. Two commission cheques. Most of them get one small bonus when you take out the loan, and then they get commissions on the sale of the stocks, bonds or mutual funds in your RRSP.
On a $20,000 RRSP loan the bonus may not be much more than $50, but the commissions on the sale of $20,000 worth of mutual funds at 4% will be $800.
“But my bank has no commissions,” you say.
Nonsense. Even if you work with one of the big banks who proudly claims to provide Fee Free services, the person sitting across the desk from you has quotas to make and annual bonus cheques riding on the outcome of this meeting. And you can bet that if they don’t make their numbers during RRSP season the manager is going to be asking a bunch of hard questions during their next quarterly review.
I recommend that you suck it up. If you decide that you absolutely must make an RRSP contribution this year, and you have already maxed out your TFSA, then I suggest setting up a monthly contribution plan and plan on getting that tax refund next year.
The sneaky little secret of the RRSP loan industry is once you head down that path it is very hard to get out of the rut. Kind of like getting in credit card debt.
Let’s say you took out that $20,000 RRSP loan. If you have a top marginal tax rate of 40% your tax refund would be in the range of $8,000 (all other things being equal). If you take that $8,000 and pay it down on the loan you will now have a monthly payment of $626.43 for the next 1 3/4 years. Ten years from now your $20,000 might have grown to $35,815.95.
The problem is that $626.43 monthly payment. Because next year, come RRSP season, you will still be paying that $626.43. I am going to guess that you won’t have saved up any money during the year to contribute. And I will also assume that you can’t afford to take out another loan and make another (bigger) payment.
If you can afford to pay more than $600 a month on a loan, why can’t you afford to make a $600 monthly contribution directly to your RRSP? If you did that for 10 years you should have around $103,851 in ten years. And all the way along you have kept your $2,800 annual tax refund in your own pocket instead of using it to pay down a bank loan.
If you can’t afford that $600 a month, it’s okay. First, always make sure you have maxed out your Tax Free Savings Account, then sign yourself up for whatever size RRSP contribution you think you can comfortably afford. Even $25 a payday is a place to start.