Rrsp loan

[black04rex]

Hello, this is my first post in the forums. I have been reading some great articles for some time and now have a question regarding my situation.

My financial adviser has suggested I get a RRSP loan to top up my RRSP's and catch up as I have lots of room to contribute. Heres the details.

RRSP Loan $22000 at 5.25% for 4 years
I am at the 34% marginal tax bracket

His plan was for me to take the $7500 refund at tax time and apply it to my line of credit paying that off. My line of credit is at $5600 with a 6% interest rate. Then take the left over refund and invest it in a TFSA. Is this a smart investment?

[OptsyEagle]

It's better then not saving any money at all. If you do all that was suggested, then it is a pretty good plan. If you are going to spend the refund, then I would suggest that you simply take the monthly payment amount that you plan to pay and just invest that amount into your RRSP automatically every month, and forget about the bank.

Just a note. An RRSP contribution will almost always result in significant tax savings but not necessarily result in a significant tax refund. A tax refund depends also on whether or not you would have owed the government money anyways. If you were going to owe the government money, due to insufficient tax withholding, etc, that can eat up a refund. So be careful when planning for a refund that you actually end up getting one.

[the-royal-mail]

Well, it all sounds fine except the idea of the loan. WTH. In addition to the 5.25% you'll be paying the bank for the loan, you'll also be paying them 2-3% MERs on whatever investments or funds you purchase within the RRSP. No wonder the bank suggested that!

There is no hurry to act on your unused RRSP room. Lots of us have tons of this room. So what? Doesn't mean it's a good idea to start forking over 8% of your money to the bank. Esp since the returns needed to cover this amount and put money in your pocket need to be around 10%, something most people these days cannot be expected to do.

Run away from this and start hanging out in CMF rather than at the bank.

[OptsyEagle]

I should also add that instead of spending the refund, if you do end up applying it to your LOC, but then subsequently re-build up that LOC over the next year or so, then that is the same as spending it.

The reason I mention this is that you would be surprised how many people completely miss that point.

As for TRM comments above. I agree that you could save some money by learning more of this stuff for yourself, but perhaps where I disagree is whether the cost of your investments is out of line. Remember, your financial advisor brought this plan to you and he/she does deserve to be paid for that work. The fact that they do earn money, does not necessarily deem it a bad idea, although you do need to be aware of the bias.

Anyway, good luck to you.

[slacker]

That's a good deal, for the bank.

It does not make sense to go into debt in order to save for retirement.

[uptoolate]

Agree with the thought that going into debt to save for retirement is a little iffy. It is pretty difficult to know what the right answer for you or any given individual is without a lot of information. As RM says, lots of people have all kinds of RRSP room and that doesn't mean that is a good idea to borrow to fill it. The interest rate on the loan is quite high, especially for an RRSP loan. And unless I am mistaken it will not be deductible.

A better way to go would be to pay down any 'bad debt' you have and then start putting what you can into low cost investments inside your RRSP without borrowing. Something like VCE at 0.10% MER and XBB at 0.23% (including HST) rather than taking the big hits on mutual fund MERs. You would likely be making smaller contributions throughout the year so using TD e-funds would likely be best until your balances build up. You could look at the Canadian Couch Potato site for help or Andrew Hallam's new book 'The Millionaire Teacher' is a good resource.

Good luck.

[financialnoob]

I get the math behind it, but there just seems something strange about borrowing $22K to pay off $6K, especially with the interest rates so similar and your income so high (based on the 34% marginal tax bracket).

Depending on what you're spending it all on, it might be better to find ways to cut back on spending for a bit and pay off the LOC and start investing into your RRSP this year without needing to take out a loan.

[OhGreatGuru]

...
RRSP Loan $22000 at 5.25% for 4 years
...
His plan was for me to take the $7500 refund at tax time and apply it to my line of credit paying that off. My line of credit is at $5600 with a 6% interest rate. Then take the left over refund and invest it in a TFSA. Is this a smart investment?

This is how banks make money and people end up deeper in debt. So the net result is that you owe the bank $22,000 instead of $5600, plus you have invested an additional $22,000 in your RRSP, on which the financial instituion (the bank too?) makes money; and invested an additional $1100 in a TFSA on which the financial institutiion (the bank again?) also makes money. Ain't modern finance wonderful?

[Cal]

I am guessing they recommended to invest in mutual funds?

[Maybe Later]

A big component is how long it would take to pay off your LOC. Convertng $5600 at 6% that you will pay off in six months into $5600 at 5.25% over four years is not a good deal. This doesn't approach $22,000.

Also, make sure you understand the math. If it were only about your refund paying off the LOC, it would only take a $16,500 RRSP loan, not $22,000. That also assumes (a) you're not already getting a refund or owe tax, and (b) you have at least that much taxable income at the 34% marginal rate to deduct.

You haven't mentioned any financial goals. Is funding your RRSP immediately your goal or your advisor's?

Finally, I would have a serious reservation about any advisor who wouldn't suggest paying down a 5% loan instead of using the extra refund for the TFSA.