Don’t DO IT!
If you are thinking of getting an RRSP LOAN,
Think again!
Did you know 8 out of 10 times,
we could be doing the RRSP loan wrong!
In today’s video,
I want to go over the pros
and cons for the RRSP loan,
and why I usually don’t recommend RRSP loan
for the average Canadians
Hey, This is Thomas!
here to help you make better choices on
your Retirement, Wealth, and Insurance
my goal is to make sure you can take 1 or 2 ideas home
and start making smarter financial decisions today
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Right now as we are entering the RRSP season,
where you’ll see lots of banks are promoting RRSP.
and for sure they also will tell you
about the benefits of getting an RRSP loan.
The banks make RRSP loans sound
very attractive for everyone.
But the reality is that an RRSP loan
is only beneficial to a few people.
Are you someone who will benefit from an RRSP loan?
Or is it better for you to stay away from it?
Let’s dive in to find out!
An RRSP loan is similar to the idea of “borrow to invest.”
It’s a special loan that you can use
towards your RRSP contributions.
From a consumer’s perspective, an
RRSP loan is attractive because
it’s easy to approve and the
interest rate is often pretty low.
The idea is that you take on the loan,
put that money into your RRSP
boost the tax return
and then you take the tax return to
pay off a portion of what you borrowed.
What’s more,
the first payment is usually deferred by 90 days
meaning that if you take an RRSP loan in February
which is before the RRSP deadline
you can generate a tax refund in April
to pay down a huge chunk of your loan.
In sense, it is an option that gives you a
better tax return as well as some time.
Let’s go through an example.
Let’s assume Jane is in the 40% tax bracket.
She has $10,000 and ready
to contribute to her RRSP before
the deadline and she still has $50,000 room for her RRSP.
What Jane could do is borrow an additional
$40,000 to make sure she can use her full
contribution room and top up her RRSP.
In this scenario she can get $20,000 back in tax returns.
She can then use the $20,000 towards her loan and pay
off the remaining $20,000 over the course of the year.
And now she has $50,000 in her RRSP account.
Perfect scernio!
RRSP loan is especially useful if
you are in the following 2 scernios
If you received a sudden huge bonus or paycheck.
If you are coming close to
retirement and have a lower income.
In these two cases, an RRSP loan can help you
to defer tax, top up your RRSP contributions and
save income for your retirement.
Now let’s have a deeper look at some situations
where an RRSP loan might not be ideal.
In the past ten years, I find that people who
use an RRSP loan find themselves in an
endless circle of borrowing and paying off debt.
So more harm than good!
I’ll go over 3 major drawbacks of the
RRSP loan and I also want to also talk
about alternatives to the RRSP loan.
This is the core problem with RRSP loans.
Usually, someone doesn’t have enough money to contribute
so they end up borrowing.
But now they are busy all year paying off the loan.
Next year in February they
are in the same situation again.
They don’t have enough money
to contribute to their RRSP.
So they take another loan –
and they are playing catch up again.
Usually the banks can offer the loan
period up to 2 to 5 or even 10 years.
That also means you are using
2 years to pay off 1 year of loan.
Remember:
the essence of an RRSP loan is to top up,
not to play catch up!
The problem here is a behavioral aspect.
If you don’t have the discipline to contribute to
your RRSP regularly throughout the year,
then how do you expect to stick to a loan
payment over the next 12 months?
If you do have the discipline,
don’t use it for an RRSP loan.
Instead, contribute to your RRSP
account regularly throughout the year.
For your RRSP loan,
you have to pay both principal
and interest together per month.
If you want to get a mortgage, for example,
the bank will look at your TDSR.
TDSR stands for “Total debt service ratio.”
This is the percentage of your income you are
allowed to use for housing or car leases.
It refers to the portion of a
borrower's gross monthly income
that goes towards repaying the monthly obligations,
including the loan being applied for.
Usually the magic number is 40 – 44%.
Meaning your monthly debt payment cannot
be 40% more of monthly gross income.
Using the previous example,
let's say you are paying$2,000 a month
to pay off the RRSP loan,
and your income is about $10,000 a month,
the rrsp loan is eating away 20% of your TDSR.
Sometimes an RRSP loan might not be reflected
in the credit bureau but would you like to take that risk
when you are applying for your next mortgage??
What’s more, an RRSP loan limits your cash flow
for the next 6-12 months because that is the usual
timeframe it takes to pay back your loan.
Think about it, even if you “only” need to pay $250
a month towards your loan –
that’s $250 you can’t use for anything else.
What if something unexpected happens?
Any extra payments around the house
of car repairs could be a risk to you.
In the end,
you might have to borrow even more money
ike a line of credit or owe a credit card balance.
And those interest rate are much higher.
Or you have to take out from your RRSP again,
which adds on your this year’s income.
As you see, an RRSP loan
can quickly turn into a vicious cycle.
So be smart about it.
Okay, as you problay can tell,
I am a person who also believe in borrow to invest,
it’s just that an RRSP loan is probably
not the best idea in many situation.
But what can you do instead?
Let me go over some of the alternatives.
If you need to top up your rrsp
but you have no additional source:
You can take out some of your TFSA
account and top up your rrsp contribution.
Unlike RRSP, the room for TFSA
will reset after the calender year.
So you can take it out in Dec 31,
and the TFSA will reset in Jan 1 next year.
A second choice will be using
a home equity line of credit.
The interest rate will be similar to an RRSP loan.
and it’s interest only, so it will not
take away too much of your TDSR.
But for sure you need to have
a property in the beginning.
Or you can consider an leverage loan,
I mentioned this concept a
while go so I won’t go over it now.
you can click at the top for details.
Either way, before your proceed,
talk to a professional to make sure
you are fit with the strategy.
Before we end this video,
I want to leave you with some final thoughts.
Please understand that an RRSP loan
can still be a good idea in some cases.
But before you take the loan, ask yourself:
Why are you doing an RRSP loan?
Is it to get more tax refund?
Or Are you simply seeking an investment opportunity?
Are you playing top-up or catch up?
And finally, what’s your overall savings strategy?
Be aware that especially during RRSP season,
banks are playing to our needs of instant
gratification with their well-timed RRSP marketing.
But an RRSP loan isn’t necessary if repaying a loan
doesn’t fit into your financial plan, or if you already
have the discipline to make regular contributions
to your RRSP throughout the year.
Now I’d like to hear from you –
do you have any experience with RRSP loans?
How was it for you?
Finally, if you like my videos, make sure to subscribe
to my channel and let me know what kind of topic
I should talk about in my next video.
I’m always open to hearing your suggestions or questions.
This is Thomas!
and I will see you in the next video!