Borrowing To Contribute

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By Gail Vaz-Oxlade

What do you do if the RRSP deadline is fast approaching and you don't have the money to make a contribution? Simple. Borrow it. Your annual RRSP contribution is an important part of planning for your future. While the adage "Use it or lose it" no longer applies to your RRSP contribution because you can now carry forward your contribution for as long as you like, borrowing for your RRSP still makes good sense, provided you don't carry the debt longer than one year.

It's far better to borrow to make the contribution than not to make the contribution at all. And RRSPs have enough other tax and investment advantages to make carrying the debt worthwhile. Not only that, but you have to weigh the fact that the interest on the loan may be more than offset by the return generated in the RRSP. Even if you choose a fixed-income investment such as a GIC, the interest calculated on the loan is calculated on a declining balance - which means that while the quoted rate may be 5 percent, you're paying that on a declining balance. Your RRSP, on the other hand, is earning interest on a tax-deferred basis to compound even more quickly.

For example, if you borrow $2400 at today's rates of4.75%, your monthly payments would be $205.19. After 12 months you'll have paid $62.21 in interest on your loan. However, if you use your tax refund of $960 (assuming a marginal tax rate of 40%) to pay down loan just five months after you took it out, your loan will be paid off in 8 months and your total interest cost would be only $38.86. The good news is, for the cost of a dinner out one night, your $2400 would grow to over $25,700 in 25 years. If you're even further away from retirement, the growth is far more dramatic.

When you look at the cost of deferring a contribution, you can see how important it is to make every contribution you can as soon as you can. The following examples assume you plan to retire at age 65 , you earn an average rate of return of 9%, you are eligible to make a $3,600 contribution and your highest rate of tax is 40%. If you are 45 years old now and decide to put off contributing that $3,600 for five years, it'll cost your RRSP $87,000 in growth. You would have to make additional contributions of $362 a month just to catch up. And the younger you are, the more impact the delay has on your savings. For example, if you are 35, the long-term cost of delaying your contribution for the same five years would be $213,000 and you'd have to scrape together an additional $592 a month to catch up.

Borrowing for an RRSP is even more attractive, because most financial institutions offer special rates for RRSP loans, providing you invest in an RRSP with their company. Some even go as far as to defer repayment of the loan for up to 120 days to allow you time to receive your tax refund, which you can then use to pay down your loan. Remember, however, that the interest-meter is always ticking so even if you aren't making payments, you are being charged interest.

So, if you don't have the money readily available, and you don't have an existing investment outside you're RRSP than you can use as a contribution, go ahead and borrow.