When to Borrow for Your RRSP

Consider borrowing when you haven't set anything aside for your RRSP or you want to increase your RRSP contribution. Either way we suggest that you borrow to make your RRSP contribution. Contributing is a sure way to reduce your taxable income as well as providing for your retirement. Borrowing to make all or part of your RRSP contribution makes sense when the interest on your RRSP outweighs the interest cost of borrowing, or if you are eligible for a tax refund.

Borrowing to Make an RRSP Contribution

Let's say you borrow $3,000 at 8% and pay it back over 12 months. Your total interest cost is $131.64 (assuming the loan is repaid in 12 equal monthly installments of $260.97 with interest calculated monthly on a declining balance). If you invest your $3,000 in an RRSP earning 6% compounded annually, the total interest earned is $180 in the first year. So you're ahead by $48.36. Plus, by making your RRSP contribution, you may receive a tax refund. For example, if you're in a 35% marginal tax rate, you may receive a tax refund of $1,050 on a $3,000 contribution. You can then pay down your loan more quickly or you could even re-invest your refund in your RRSP for next year.

Maximizing Your Contribution

If you have already put some money into your RRSP over the year, but are wondering how you can put enough in to reach your contribution limit, it may make sense to borrow and then use the tax refund on your total RRSP contribution to pay back the loan. For example, let's say your RRSP limit is $4,571 for the year, you have already contributed $3,200 and your tax rate is 30%. Therefore, you would need to borrow $1,371 to maximize your contribution. Next, divide $3,200 by 1 less your marginal tax rate. $3,200 / (1-30%) = $4,571

Your total contribution would be $4,571 based on borrowing $1,371, which is also what you'd receive from your tax refund ($4,571 X 30% tax rate). You could use your refund to repay the loan in full!