Every year around 6 million Canadians contribute to their RRSP making it the most popular way of saving for retirement. But did you know that your RRSP is adaptable? That you can use it before retirement in innovative and profitable ways?
Rather than thinking of your RRSP simply as a passive fund, you pay into you can think about it as an asset, against which you can borrow in order to invest in property or further education. For a closer look at how to do this check out our home buyer's plan now.
You can also use your RRSP as a way to grow your capital by borrowing from banks to pay in contributions above what you can set aside from your income.
What is an RRSP loan?
An RRSP loan is a type of loan that allows you to contribute to your Registered Retirement Savings Plan by borrowing money. Ideally every year you should maximize your RRSP contributions in order to save for retirement and take advantage of the highest possible tax deduction. If you are unable to max out your contribution you can take out a loan to cover the shortfall.
To see how much you could be saving for retirement with an RRSP you could use an RRSP calculator.
As expenses continue to rise you may find yourself caught in a dilemma. You are using more of your income to cover bills and monthly expenditures and therefore are contributing less to your retirement plan. How do you cover yourself today without taking away from your future security?
One way to maximize your RRSP contributions and continue to invest in your retirement is to take out an RRSP loan from a bank.
By making a higher contribution you will receive a tax deduction and perhaps even a tax refund. With careful calculation, you could even use the tax refund to pay off most or all of the original loan.
Speak with a financial advisor about opening an RRSP today
How does an RRSP loan work?
An RRSP loan is based on the leverage effect. In effect, taking out this loan allows you to make a larger investment than just saving. It also allows you to benefit from a significant tax refund.
Furthermore, the repayment of the RRSP loan is generally flexible. You can choose a weekly or monthly repayment. It is also possible to prepay all or part of your RRSP loan.
How do I take out an RRSP loan?
Before you decide to take out an RRSP loan, there are several factors to consider:
- Your ability to repay: you shouldn't borrow money you can't repay. Your ability to make repayments should be a key consideration.
- Your borrowing capacity: taking out an RRSP loan will increase your debt load. So, before taking out this type of loan, you should think about all your other current or future loans.
- Your age: At an advanced age, you will be obligated to take out a short-term loan therefore if you are already retired, you will need to repay your RRSP loan quickly.
- Your ability to be disciplined: taking out an RRSP loan is not just a simple act. A responsible attitude to repayments and care in setting up your savings are important factors in making your RRSP loan work.
For example: for a $2000 RRSP loan with an interest rate of 6%, you will have monthly payments of $176.6 over 12 months.
A few other questions you should ask yourself before taking out an RRSP loan are:
- How does the cost of my RRSP loan compare to the benefits it will afford me?
- Am I capable of managing the risks involved, such as having to pay back the principal and interest even if the value of my investment decreases?
When is it worth taking out an RRSP loan?
Taking out an RRSP loan is useful in many situations, but it is especially useful in two specific cases:
- If you are about to retire: as mentioned above, taking out an RRSP loan before you retire can be advantageous. It allows you to make up for lost time by accessing a large sum of money. For example, if you are 65 years old, you could take out a $20 000 RRSP loan over a 10-year period with an interest rate of 4% and you would benefit from $15 706 in additional savings.
- If you want to buy your first home: first-time home buyers can use the RRSP loan to buy a house by increasing their down payment. The strategy is to use an HBP (Home Buyers' Plan) in addition to your RRSP loan. The maximum amount that can be withdrawn is $25 000. Also note that to be in good standing, you must leave all the money in your RRSPs for 90 days. This is a great way to get the necessary funds for the purchase of your first property. For example, if you take out a $25 000 RRSP loan to buy your first principal residence, the return on this investment will help you finance your home.
What are the disadvantages of an RRSP loan?
The RRSP loan is based on the principle of leverage. Even though it has several advantages, it is necessary to point out some disadvantages:
- Repayment capacity: like any loan, the RRSP loan necessarily involves a debt. The ability to repay must therefore be a key consideration before taking out an RRSP loan. Wise financial planning takes care to avoid any risk of insolvency.
- Market risks: it is impossible to predict the exact behaviour of the RRSP loan market. The risk that your investment will decrease is therefore real and can jeopardize your solvency.
- Risks related to interest rates: you should be aware that rates may increase. The cost of your loan will therefore increase. Keep in mind that you must always be able to repay your loan.
What are the RRSP loan interest rates?
You can take out an RRSP loan with either a fixed or variable rate. So what are the differences?
A variable-rate RRSP loan means that the interest rate is not fixed in advance. This rate may vary according to market conditions. This means that your monthly payments may be adjusted (higher or lower) and the duration of your contract may change. There are several advantages to variable interest rates: they are lower when you take out your RRSP loan than fixed rates and you can benefit from additional reductions depending on market conditions. However, on the other hand, they can increase if the market is not doing well.
Fixed interest rates mean that when you take out your RRSP loan, the rates remain constant throughout the term of the contract. Several formulas can be offered to you: an RRSP loan with constant maturities, progressive maturities or an RRSP loan with adjustable maturities.
What are the best RRSP loans?
Here is a table listing the RRSP loan products offered by the main providers, with their rates and fees:
|RRSP Loan Provider||Type of loan||Interest Rates (%)||Terms (in years)||Repayment flexibility|
|Desjardins||Desjardins Accord D RRSP financing||3.45 - 4||1 to 3|
|Tangerine||Tangerine RSP loan (note must be paid into Tangerine account)||7.2 - 8.75||1 to 5|
|RBC||RBS RRSP loan||3.2||1 - 10|
|BMO||BMO Retro-Activator RRSP loan||1 - 15|
|TD||TD RSP loan||3.7||1 - 10|
|Industrial Alliance||iA RRSP loan||2.25 - 3||1 - 10|
|CIBC||CIBC RRSP Maximizer Loan||1+||1 -10|
Speak with a financial advisor about opening an RRSP today
How much to borrow for your RRSP loan?
To understand and know how much you need to borrow for your RRSP loan, let's take a concrete example. You want to take out an RRSP loan for $10 000 at a prime rate of 3.7% and a repayment period of 4 years. Every month you will pay $224.45 for a total interest cost of $773.52. If your RRSP has grown by more than 7.7% over these four years then you will have made a profit.
A good RRSP loan strategy involves calculating the rate of return and making sure that remains above the interest payable on your catch-up RRSP loan.
To find out how much to borrow, it can be helpful to use a loan calculator.
When is it better not to take out an RRSP loan?
Did you know that the debt ratio of Canadians is 173%? This represents an average debt for each consumer of more than 18 000 dollars. Your debt ratio is therefore the fundamental data to take into account if you want to take out an RRSP loan. As a general rule, specialists advise not to take out an RRSP loan if your debt ratio is higher than 35%.
At a time when interest rates are going up, a fixed-rate loan may be more attractive.
Is it possible to prepay an RRSP loan?
Most banks allow you to prepay your RRSP loan. You can, therefore, at any time, repay all or part of your RRSP loan. Note that there are no fees for early repayment.