Every year around RRSP contribution season, this question seems to pop up: should you borrow to invest in an RRSP? The idea can look good on paper when you crunch the numbers.
Our suggestion? Crumple up that paper. Chuck it. Don’t do it.
The idea of borrowing to invest in an RRSP could be a bit counter-intuitive to you (which is a good thing). Even so, many Canadians do it. In fact, as we noted in the Globe & Mail last year, on a much bigger scale, some wealthy Canadians will use debt financing to pay for investments. That does happen. Why not borrow for RRSPs?
Maybe you recognize yourself in this situation: you never set up regular contributions to an RRSP throughout the year. You meant to make a lump sum payment, but that just never happened. You were coming up on the deadline and realize your RRSP payment got re-routed to pay for a vacation or emergency expense. That, or it got chipped away by monthly expenses. (That is why setting up automatic contributions is so helpful for many people: when you don’t even notice the money come out of your account, you don’t really miss it.)
Or, let’s say you actually did manage to invest something into your RRSPs. You’re just looking to top it up even more. You somehow managed to avoid the debt burden and interest payments of so many of your fellow citizens. Still, you’re in a situation where you just don’t have the money to put into an RRSP. That is, unless you borrow it.
You understand the benefits of having RRSP contributions (ie. lowering your taxable income and potentially getting a tax refund, while helping prop up life savings for retirement).
Our two cents? Borrowing to invest in an RRSP is a really bad idea
The reason is simple: we’re not all that confident that you’re going to pay that loan back fast enough to make it worth your while. The truth is that if you’re like most Canadians, you just won’t pay it back quickly enough to make it worth your while.
When it comes to consumer debt, Canadians are already the most indebted people on earth. As CNBC noted:
The OECD found Canada’s household debt-to-GDP ratio had ballooned to 101 percent — significantly higher than any of the 35 developed and developing countries the group monitors
Not only that: Canadians are increasingly raiding their RRSP accounts just to make their mortgage payments, pay off car loans and cover their grocery bills. (Now, some of those withdrawals are for the Home Buyers Plan. That is not a bad thing.)
But there aren’t really many other good reasons to make early withdrawals from your RRSP account. You’re going to get killed on taxes. You won’t get that RRSP contribution room back. And of course, your money is no longer working for you as an investment. Withdrawing money early from your life savings when it should be working with you is a bad sign.
These trends I’ve listed above tell me that if I took a poll of our blog’s readers, a good proportion of them would already be in debt up to their eyeballs.
That being the case, we’re not going to recommend that Canadians borrow even more to invest in an RRSP.
You’re not in debt. You feel fully prepared to pay back your loan promptly. But still, nope
Maybe you’ve really done your homework. You’ve paid off any high consumer debt like credit cards. You feel like you’re sitting pretty right now.
If the loan’s interest rate is under 3 percent, you can pay it back promptly and still probably get a decent return, right?
That’s a big if.
Your cost of borrowing can outmatch any potential return on investment if you fail to pay it back within a year. And don’t forget: interest rates aren’t static. If you carry the debt long enough and the interest rate rises, your original calculation of a positive return might become worthless. As we’ve noted above, many Canadians who are trying to cover their debts aren’t succeeding.
The road to a very hot place is paved with good intentions. Is it realistic that you won’t run into a cash flow problem again when you’re trying to pay back the loan?
Some good ideas for contributing to an RRSP
After a whole section worth of gloom and doom, enjoy these tips that can help you make the most of your situation.
Start setting up automatic contributions. If you’re like many Canadians who have come up short at RRSP contribution season and were thinking of borrowing, it’s because you didn’t keep a lid on spending. You didn’t think about saving, so you didn’t save. But with automatic contributions, you don’t think about investing… but you invest anyway.
Some people are dead-set against automatic contributions because they would prefer to time the market. They want to invest when the market is down, so that they get a bigger return when it bounces back. In reality, it’s hard even for seasoned finance professionals to time the market. For most RRSP investors, an intent to time the market simply results in missed opportunities. That’s partly why most individual investors underperform the funds they invest in.
The safer bet? Just contribute a steady amount every month (possibly changing that amount if you get a new job or your circumstances change). Fire and forget — and when RRSP season comes around, you won’t need to think about borrowing to invest.
Run the numbers for what you will actually need. All that money you wanted to borrow to plunk into an RRSP? You might not actually need all or most of it in the first place.
Figure out how much you really need to contribute to your RRSP in 2018. While the maximum contribution for the 2017 tax year is 18% of your income, or $26,010, whichever is less. But the trick is to optimize, not just maximize, so you have enough to live as you want up until age 100.
Just contributing the maximum possible amount every year is a short-term investing strategy. By over-contributing, you can actually increase your tax liability. You get to a point that when you have to start withdrawing your savings, you’re effectively paying the CRA a lot more than they might deserve, due to OAS clawbacks.
Consider putting some of that RRSP contribution into a TFSA. As we noted in that same article on short-term vs long-term strategy we quoted above:
“Simply save enough money in an RRSP to cover your current living expenses in retirement until age 100 and divert the rest to your TFSA or other savings accounts.”
Instead of borrowing to invest your maximum RRSP contribution, just save as much as you need to. When you put the rest into a TFSA, you can have better cash flow for short-to-mid-term expenses.
Run the numbers for your TFSA or RRSP with our handy calculator
To help you figure out your optimum amounts to contribute to your RRSP or TFSA (perhaps with automatic contributions, as we noted above), we have some easy-to-use financial calculators.
Need help crunching those RRSP optimization numbers with our calculator tool? WealthBar clients get unlimited financial advice. Talk to one of our financial advisers for more ways to grow your money (without needing to borrow to invest).