Considering borrowing funds to contribute to your RRSP? Here’s what you need to consider.
Certain carrying charges and and interest paid on funds borrowed to earn investment income can be claimed as an expense on your personal tax return. However, interest paid on funds borrowed to contribute to your RRSP is not tax deductible. Therefore, you should try to make your RRSP contributions with cash available on-hand. If you are considering borrowing funds to invest, it is almost always preferable to make investments where the interest paid will be tax deductible.
Borrowing funds to make your RRSP contributions is definitely still an option to consider. The most common argument discussed in favour of borrowing to invest in your RRSP is ‘you can use your income tax refund to pay off a portion of the borrowed funds’.
Using your refund to pay off the debt
Let’s say that you know you want to make an RRSP contribution of $10,000, but you do not have the cash to make the contribution. You could borrow the $10,000 late in the year, or within the first 60 days of the new year, to minimize the length of time you are paying interest on the borrowed funds. After making the RRSP contribution and filing your tax return, you can expect a reduction in income taxes owing that you would not have otherwise received without the contribution. Let’s say that your marginal tax rate is 43% (i.e., 2015 Federal and Ontario tax rate on income over $89,401 up to $138,586). You can expect a reduction in taxes of 43%, or $4,300 on that $10,000 contribution. More specifically, you can pay-off $4,300 of the $10,000 borrowed within just a few months.
You need to have the discipline of allocating the income tax refund received to pay off the debt. Once the refund is in your hands, you may be tempted to use it to pay off other expenses.
Perhaps you have other debt that you are paying a very high interest rate on. You should consider paying off that debt first with any cash you do have, or consolidating that debt at a more favourable interest rate, before you take on any more debt.
Lump sum investing
Borrowing funds would likely be done in a lump sum fashion, as would your RRSP contribution and investment. It is often advised to invest over time and take advantage of dollar cost averaging. Making a lump sum investment may turn out well, but it may also result in you investing in the flavour of the month or making an investment at a relatively high price.
Payment in kind
If you have investments in a non-registered investment account, you should consider transferring those investments to your RRSP. You will be required to pay income tax on any previously unrealized capital gain. However, capital gains are taxed at a relatively low rate, and the income tax paid thereon is most likely to be offset by the income tax refund generated by the RRSP contribution.
Deciding whether borrowing funds to invest in your RRSP is a good idea for you can be a complex decision to make. Your best bet is to pay yourself first if you can – more specifically, contribute to your RRSP throughout the year.
Caveat: The information in this publication is current as of the time it was written. This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Deuzeman & Associates to discuss these matters in the context of your particular circumstances. Deuzeman & Associates does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.