Awa Sow
A Registered Retirement Savings Plan (RRSP) is an investment account primarily used for retirement savings. Any interest or investment income you earn in an RRSP is tax-free as long as the funds remain in the account. Saving for retirement is one of the most important financial steps everyone should take.
RRSPs have 3 special tax benefits and it’s important to understand them so you can get the most of out of them. For more information on how RRSPs work click here.
What’s an RRSP Loan?
An RRSP loan is just as the name suggests. It’s a loan you can contract for the purpose of investing in an RRSP. Essentially, an RRSP loan allows you to get a loan in order to save for retirement. The idea behind this is you make a considerable contribution to your RRSP to hopefully get a refund that you will put towards the RRSP Loan. The rest of the loan is paid monthly until the debt is paid off.
“RRSP season” (the first 60 days of the year) is the time financial institutions start preaproving clients for RRSP loans and selling you benefits of getting one. But what would drive someone to get a loan in order to save for retirement? When does it really make financial sense to get a loan for the purpose of retirement saving? Below are the pros and cons of getting an RRSP loan.
The pros of getting an RRSP Loan
1. RRSP loans help you maximize your retirement savings
Typically, you can invest up to 18% of your previous year’s earned income into an RRSP or a maximum amount whichever is smaller. For 2021, this maximum amount was $29,210. Your contributions accumulate every year. Therefore, even if you’re not able to make your total allowed contributions every year, your contribution limit is not lost and you can recontribute as long as you are still eligible to contribute to an RRSP.
It might not be financially possible for most people to make the full contribution to their RRSP every year. An RRSP loan gives you the funds you need to meet your full RRSP contribution amount. This gives you the opportunity to start growing your retirement savings early on and start getting the benefits of compounding.
2. RRSP loans have low rates
RRSP loans are usually at the bank’s prime rate which is currently at 2.45%. The Prime rate is the interest rate that lenders use to determine the interest rates for many types of loans. For RRSP Loans, Banks usually lend up to $50,000 with repayment periods between one and 10 years.
3. You can pay off part of the RRSP Loan with your Tax refund
When you put money into your RRSP, you deduct that amount from your income when you file your tax return. Simply put, this makes it so that you are entitled to a tax refund.
This is the main benefit that financial institutions sell you when advertising the RRSP Loan: the fact that you can pay off the amount of the RRSP loan with the tax return you receive from the contribution.
There usually also is a possibility to defer the first payment by 90 days. This is mainly so that an RRSP loan that is taken in February before the RRSP deadline has enough time to generates a tax refund so you can use it to pay down some of the loan.
The cons of getting an RRSP Loan
1. An RRSP Loan is a debt
It goes without saying that this is the most obvious con of an RRSP Loan. The fact that you’re getting into debt to save for retirement might not sit well with you. And for good reason, especially if you are in debt and trying to be debt free. If you feel your budget can’t handle additional monthly payments, then an RRSP Loan might not be a good idea.
2. You might not get the expexted tax refund
If you are one of those people who is considering an RRSP Loan with the expectation of a high tax refund, then think twice. You might still get a tax refund, it just might not be as much as expected. The taxation system is a complex world, so you should do your due diligence and research this part with your accountant or your tax advisor before commiting to getting an RRSP Loan.
The bottom line
If you can keep the cost of getting an RRSP Loan low and if you can repay the loan in a reasonable time frame, the benefits will be greater than the cost and it might make financial sense for you to consider it.
The more you can save for retirement and the earlier you do it, the better. The best way to save for retirement is to set up automatic monthly payments into your account so you don’t have to think about it later in the year. Saving for your retirement should be a priority for you so you should include these savings in your budget every month. Don’t be a procrastinator and wait until the last day of “RRSP season” to start thinking about your RRSP contributions.
