RRSPs: To borrow or not to borrow?

Like a lot of Canadians, Laurie Stephenson hasn’t always had enough money to max out her RRSP. But that’s never stopped her from topping up her account.

Over the years the Certified Financial Planner (CFP) with Halifax-based Stephenson Daigle Financial has borrowed money in order to maximize her contributions. One time, years ago, she had only $10,000 to invest, so she borrowed another $10,000 to reach her limit. When she received the tax refund she immediately paid off the loan.

“Generally, borrowing to invest is a good idea,” she says. “I’ve done it for myself and I’ve done it for clients.”

At one time, borrowing, or leveraging, wasn’t a feasible way to max out an RRSP — interest rates were too high. But with today’s low rates, taking out a loan is more affordable. Many financial institutions specifically offer loans for RRSPs and the borrowing rate is around prime, about 3%.

It’s low enough that, in many cases, a tax refund could pay back the loan with interest. Stephenson has a client who’s putting in $12,000 of his own money and borrowing $8,000. She says he’ll get enough money back to pay back the bank.

The main benefit of borrowing is that it helps people save more for retirement. “It helps you get there quicker,” says Stephenson. “You’re saving earlier.”

But, she cautions, don’t take out a loan you can’t pay back within two years. She’s had clients who’ve borrowed large sums that could only be paid back over five years. That’s a mistake, she says, because interest rates could change and you don’t want a loan hanging over your head for more than a couple years.

It also only works if you actually use the tax refund to pay back the loan, or at least a big part of it. One of her clients who borrowed money ended up using the refund for something else and wound up with a huge debt that wasn’t factored into his financial plan.

Greg Habstritt, author of “The RRSP Secret: Defend and Build Your Wealth with This Powerful Investment Strategy” says that many people aren’t disciplined enough to use the refund to pay off the loan. Plus, if the RRSP loses money, then you could be caught paying off a loan that’s worthless.

“(Borrowing) is a horrible idea,” he says. “It could end up magnifying the loss.”

Typically, one of the big benefits of borrowing money for investment purposes is that the interest is tax deductible. However, that’s not the case with an RRSP loan. The main advantage with borrowing is that, if returns go up, you’ll have a lot more in your account than you would have otherwise.

Of course, in today’s market it’s impossible to predict which direction returns will go. The thinking is still that over the long-term portfolios will gain in value. But Habstritt says, the financial crisis, which wiped out many portfolios, proved that’s not always true.

Whether to borrow or not really depends on the investor and the situation, says Stephenson. Don’t borrow if you have big expenses coming up, like university tuition, or if your cash flow can’t accommodate new monthly payments.

Also make sure leveraging is something you feel comfortable doing. Stephenson says that many people borrow and then forget why they took out a loan. “People have short term memories about this stuff,” she explains. “They wonder, ‘why did I do this?’”

But for disciplined Canadians who are committed to pay off the loan, borrowing—especially in today’s low interest rate environment—can make sense.

“People are terrible savers,” she says. “This is a great way to force yourself to save.”