I logged into my Canadian bank account today and was faced with an ad for a line of credit with the preface that borrowing money to max out your RRSP would be a worth while thing to do.
This is of no importance to me at the moment as I’m not earning Canadian income but it got me thinking. Is this a worth while approach?
In short, not if you could max it out without borrowing.
For non-Canadian readers: an RRSP is a tax deferral tool similar to a pension where you offset taxes in your higher earning years and pay your marginal tax rate in retirement once your income is (typically) lower.
Although this post looks at RRSPs in particular, the concept applies to any tax deferral investment tool.
The case against borrowing to max out your RRSP
Similar to management fees in regular investment accounts, even small percentages on a loan will decimate your long term earnings.
Put simply, if you do this every year and are paying 4.25% on your loan and your RRSP is earning 8% (after inflation) then your RRSP (or pension) is actually only growing at a rate of 3.75%. Or in other words, the bank is taking over half your profits and you’re taking on all the risk.
Over 30 years this means you end up with 70% less in your RRSP if you do not use your tax refund to pay down the loan than if you had maxed it out without a loan.
The other down side is that you now have a loan to repay which is an added risk and stress if you should get sick or lose your job.
If you are planning on using your tax refund to pay off part of the loan, this is a better option but still results in 30% – 56% less in your RRSP over 30 years depending on various income brackets which I’ll go into below.
Assumptions
- I used Ontario tax rates as an example
- I assumed a loan is taken out for the full contribution room for one year. Currently 18% of your gross income
- The loan interest rate is 4.25% as per the offer I saw today (prime + 0.5%)
- RRSP growth at 8% (average 10% historical stock market growth minus 2% for inflation)
Below is a table showing how the numbers work out depending on various income levels.
Walking through one example, say you are earning 50,000$, you take out a loan for 9,000$ and get a tax refund of 2,779$ which you use to pay down the loan.
You now need to pay down 518$ each month to pay off the remaining 6,221$ of your loan.
Your remaining loan incurs 264$ of interest where your RRSP earns 720$ leaving you with a net earning of 456$ in year 1.
Option 1: Don’t borrow and contribute through the year
If you hadn’t borrowed and made contributions through the year your 9,000$ would grow to 90,564$ over 30 years.
Option 2: Borrow full amount and use tax refund to pay back part of the loan
If you borrow the full amount and repeat this process every year your 9,000$ contributed in year 1 will have grown to 39,596$ in 30 years. This is 56% less than if you had just contributed throughout the year.
Option 3: Borrow full amount but use tax refund for something else
If you were tempted to keep the tax refund of 2,779$ to spend on something else then your 9,000$ would only grow to 27,157$ over 30 years. Resulting in 70% less than if you maxed it out through the year instead.
Option 4: Borrow full amount and contribute your tax refund to your RRSP
I’ve seen in other calculators that borrowing to max out your RRSP and using the tax refund to add to your RRSP as well results in more money than if you contribute through the year without borrowing but this didn’t add up in my calculations as you are still paying the full 4.25% on your loan every year and even though your initial sum invested is higher, you’re still only growing at 3.75%. You also have increased risk by having higher loan repayments through the year.
By my calculations this approach results in your 11,779$ (9,000$ + 2,779$ tax refund) growing to 35,543$ after 30 years or 67% less than if you contributed through the year.
There’s also the question of this value being over your max contribution room for the year which results in you having to pay a tax of 1% per month on excess contributions that exceed your RRSP deduction limit by more than $2,000 unless you withdrew the excess amounts.
See how these figures play out for various income levels below.
| Gross income | 20,000 | 35,000 | 50,000 | 70,000 | 90,000 |
| Income taxes | 1,665 | 4,673 | 8,060 | 13,990 | 20,205 |
| Average tax rate | 8.33% | 13.35% | 16.12% | 19.99% | 22.45% |
| Tax refund | 2,526 | 2,612 | 2,779 | 4,274 | 5,476 |
| Max RRSP contribution room (18% of gross) | 3,600 | 6,300 | 9,000 | 12,600 | 16,200 |
| Annual interest owed once offset by tax refund | 46 | 157 | 264 | 354 | 456 |
| RRSP interest earned (8%) | 288 | 504 | 720 | 1,008 | 1,296 |
| Net earnings offset by tax refund | 242 | 347 | 456 | 654 | 840 |
| Remaining loan after tax refund | 1,074 | 3,688 | 6,221 | 8,326 | 10,724 |
| Monthly loan repayments over 12 months | 90 | 307 | 518 | 694 | 894 |
| Growth on 1 years contribution without borrowing | 36,226 | 63,395 | 90,564 | 126,789 | 163,015 |
| Growth on 1 years contribution using refund to pay down loan | 25,419 | 31,507 | 39,596 | 57,518 | 73,846 |
| Percentage difference | 30% | 50% | 56% | 55% | 55% |
| Growth on 1 years contribution not using refund to pay down loan | 10,863 | 19,010 | 27,157 | 38,020 | 48,883 |
| Percentage difference | 70% | 70% | 70% | 70% | 70% |
When does it make sense?
Make your interest tax deductible
One hack is to sell off some other investments (if you have some outside of your RRSP) and use that to max your RRSP. Then, consider borrowing to replace the investments outside your RRSP. This way, the interest on your loan will be deductible (since you’ll be using the borrowed money to earn income in a taxable account). You’ll be entitled to a deduction for the market value of the assets contributed to your RRSP, assuming you have sufficient RRSP contribution room.
Some things to keep in mind here:
Capital gains
First, you’ll be deemed to have sold those investments you transfer to your RRSP, so you might trigger taxable capital gains if they’ve appreciated in value. Having said this, your RRSP deduction will more than offset the taxable amount in this case.
Capital loss
Second, if the investments have declined in value, your loss will be denied when you transfer the assets to your RRSP (as a registered transfer between fund providers), so you’d be better to sell those assets first, then contribute the cash to your RRSP, which will allow you to claim the capital loss.
If you do sell your assets at a loss, be careful not to reacquire those same securities inside or outside your RRSP within 30 days of your sale, otherwise the superficial-loss rules will kick in to deny the loss.
Interest free loans
Another option to consider is if you could get a credit card where you pay 0% interest on cash advances for 6 months, use that to max out your RRSP and then pay off the credit card before you incur any interest.
Your growth wouldn’t be affected but you would be under additional pressure to pay of the loan before interest kicks in.
Smaller top ups
Say you’ve contributed through work throughout the year and you only need to top up your contribution by the same amount as your tax refund, then you should be able to pay off the loan in full once you get your tax refund and it shouldn’t reduce your growth unless the interest is charged in full regardless of when you pay it off.
So in the 50,000$ income example, say you’ve contributed 6,221$ throughout the year (or 239$ over 26 pay periods), then you only need 2,779$ to max out your contribution room. If you took out a loan for that amount and got that same amount as a refund, then the only interest you’d incur would be that which accumulated between taking out the loan and getting your tax refund.
I’ve seen some loans offer the option to delay the start date of your repayments by up to 90 days (enough time to get a tax refund), but not sure how the interest works on those, I’m assuming you are still being charged interest even if you aren’t making repayments yet.
Summing it up
Here is a summary of the different options using the 50,000$ income example above:
| Option | Growth after 30 years on 1 years contribution | Percentage difference compared to not taking out a loan | Monthly repayments |
| Max out your RRSP through the year without taking out a loan | 90,564 | N/A | 0 |
| Take out a loan for full contribution room and use tax refund to pay down some of the loan | 39,586 | -56% | 518 |
| Take out a loan for full contribution room but don’t use tax refund to pay down some of the loan | 27,157 | -70% | 750 |
| Take out a loan for full contribution room and contribute tax refund to RRSP as well | 35,543 | -67% | 750 |
| Take out 0% interest cash advance credit card, use tax refund to partially pay off | 90,564 | 0% | 1,036 (over 6 months instead of 12) |
| Contribute through the year and only take out loan for as much as your tax refund would be and pay off loan in full with tax refund | 90,564 | 0% | 2,779 once off payment from tax refund |
| Max out RRSP by selling other assets and taking a loan to re-buy the assets sold, making the interest tax deductible | Should be close to 90k but depends on gains or losses of the assets sold | Should be close to 0% but depends on your gains or losses of the assets sold to top up | 518 |
Personally I think any of the options that “make it worth it”, are too much effort and risk. I would just start as you mean to go on and try to max out your contribution room going forward throughout the year.
Keep it simple!
As a result, if life throws you something unexpected and you need to stop contributing as much, then you have the breathing room to make those adjustments, which is not the case if you’d taken out a loan.
Calculators
If you’d like to run your own figures through here are some tools I used to help with my calculations:
Used to calculate tax rates per Province (it shows all Provinces in one calculation, just enter your gross income and hit enter)
Used to calculate estimated tax refund
This shows the difference in the first 4 options in the table depending on variables you enter. I’m not sure about the Plan 1 option as I couldn’t get the numbers to work out the same.