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What is an RRSP Loan?

An RRSP loan is a loan taken from a financial institution for the purpose of contributing to an RRSP account. Usually, the individuals taking the loans are short on funds to contribute to their RRSP and will take out a loan to make up the shortfall.

There are several reasons as to why somebody would take an RRSP loan, often referred to as RRSP loan strategies.  The main strategies are:

• Gross up loan: The borrower borrows just enough that their resulting tax refund from the increased contribution almost cancels out the loan itself.
• Top-up loan: The borrower borrows the required amount they need to use up the yearly RRSP contribution limit. The resulting tax refund is then used to pay back a significant portion of the loan.
• Catch-up loan: The borrower borrows a significant amount to use up a substantial portion of their overall unused contribution limit. The resulting tax refund is then used to pay back a portion of the loan.

Advantages

Let’s have a look at some of the advantages of taking RRSP loans

• Increase tax refund and quicker repayment: This is the obvious one, and what makes RRSP loans such an effective tool. By increasing your RRSP contribution through the loan amount, you increase your tax refund. This increase in refund can then be used to pay off the loan faster.

• Lower interest rates: It is common that the loan interest rates for RRSP loans are lower than for other investment loans. This is due to several reasons, such as faster repayment (see above) and the fact that you will be investing the loan with the financial institution you took the loan from, so the institution is essentially earning money twice (loan interest + investment fees).
• Increased future returns: By investing more funds sooner, you’re allowing more time to the loan amount invested to compound.  

Disadvantages

Now let’s have a look at some disadvantages to RRSP loans

• Risk of compounding losses: If the investments you purchase lose money, you are compounding your losses since your investments have not only gone down, but you also still owe the loan amount.
• Interest costs: The financial institution is charging you interest for the unpaid balance of the loan, which adds to your overall costs.
• Increased debt: If you already have debt amounts such as credit card balances and a mortgage, the RRSP loan adds to this debt burden.

Are RRSP loans worthwhile?

This will depend on your overall financial situation. If you are a low-income earner struggling with debt, taking out an RRSP loan does not make much sense. The benefit of the increased tax refund will be minimal due to your lower tax bracket, and you would be adding more debt to your debt burden.

If you’re a higher income earner and have your debt under control, an RRSP loan can make sense because you get the double benefit of a substantial increase to your tax refund, and the use of that tax refund to play off the loan faster.

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