When It Makes Sense To Borrow For Your RRSP

Wealthy people often borrow to invest. They call this 'leveraging' or 'leveraged investing' - but what it really boils down to is using someone else's money to make your own investments. You don't have to be rich to benefit from the value of 'leveraging'. In fact, you may be able to take advantage of a 'leveraging' strategy right now that could help you save on taxes and could increase your potential retirement income at the same time.

If you're like most Canadians, your Registered Retirement Savings Plans (RRSPs) will be an important source of income during your retirement years. And, if you're like most Canadians (a whopping 78 per cent in the 2003 tax year[1]), you probably have unused contribution room in your RRSPs. To make the most of the potential tax-saving and income-building advantages of your RRSPs, you should fill up every bit of your unused contribution room as quickly as you can - and leveraging can be an effective way to do just that.

Borrowing in order to contribute to your RRSPs could pay off in two ways: First, you'll increase the size of your tax refund and second, you'll have more money growing inside your tax-deferred retirement plan. Here's an example: assume that your RRSP contribution limit is $3,000 this tax year. (The actual amount of your RRSP contribution room is provided on the Notice of Assessment you received from the Canada Revenue Agency after filing your tax return last year.) Depending on your tax bracket, a $3,000 contribution could net you nearly $1,500 in tax savings at the time you file your tax return in the form of a larger tax refund, while also potentially adding $30,188 to your retirement plan over 30 years (on a pre-tax basis, at an annual compound rate of 8 per cent ). And, that's for just a single contribution of $3,000!

The government allows you to accumulate and carry forward all your unused RRSP contribution room from previous years back to 1991. You can make up the unused RRSP contribution room at any time, but sooner is better because you'll have more money growing on a tax-sheltered basis inside your RRSPs.

The issues to consider from a leveraging strategy are these: Borrowing at a low interest rate and paying off the loan quickly, otherwise the cost of borrowing can diminish your potential tax savings and investment returns. Financial institutions often offer RRSP loans (which are really loans meant only for the purpose of contributing to your RRSPs) at prime rate or lower. For top-up loans, limit the payback schedule to one or two years.

[1]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 investments.

For larger loans, don't exceed five years. The leveraging strategy often works even better when you use your increased tax refund to repay the RRSP loan even faster.

Your professional advisor can help you map out an RRSP leveraging strategy that works best for you.