Digging A Deeper Hole

digging

No doubt most of us struggle to come up with enough cash to buy our RRSPs.  Most Canadians have a huge amount of RRSP contribution room built up from previous years.  The fact is with rising costs, there is little money left over that ordinary Canadians can use to contribute towards retirement planning.  Cars, smartphones, gym passes and nights out on the town take a hefty chunk out of our pockets.

It’s no wonder that when RRSP season comes around and Canadians visit their local financial institutions, financial advisers are encouraging Canadians to take out loans to contribute to their RRSPs.  “Think of the bills you can pay off with your tax refund.  Or maybe that big screen TV you want to purchase.”  is probably something that a loan officer would tell you.

Well let me tell you why it’s not a good idea to take out a loan for your RRSP.

It’s not a refund – I wrote this before in my last post.  It’s a tax deferral.  The fact that you borrow to contribute money into your RRSP puts you in a bigger hole.  That money you borrowed has to be repaid, and the tax “refund” you get back has to be repaid too when you take your RRSP money out.  Double loss.

Your bank officer is out to make a buck – Think of when your bank actually helps you?  Never!  Essentially the bank is making you borrow more money so you can pay the bank even more of your hard earned dollars in interest.  Do I see bigger bank profits ahead?  Of course!

RRSP loans are not tax deductible – A loan to contribute to your RRSP is not tax deductible.  Unlike an investment loan where you can write off the interest as an expense, it doesn’t work for an RRSP.

You have better priorities – Most Canadians are already carrying heavy debt loads with lines of credit and credit card debts.  The interest rates of those loans would probably outstrip any capital appreciation or interest income invested in RRSPs.  Pay off high interest loans first.

Poor investments – It’s true that interest rates for loans are at an all time low.  Taking out a loan might make sense for a financial savvy investor, but the average Joe knows nothing about investing and will throw it into a GIC.  A GIC making 2% is not going to outstrip the interest payments on the loan.  Investment fail!

You’ll spend the tax credit – Most Canadians are going to spend the cheque that comes back from the government once they get it.  It’s force of nature for us to do that.  If you’re trying to justify having money in an RRSP just so you can get a few hundred dollars back as a tax “refund”, then you’ve got your head on backwards.

You gotta pay it back – Last time I did the math, putting money into RRSP with a loan balances adds $0 to your net worth.  It’s great seeing money in an RRSP but now you’ve got another loan to pay off.  With Canadians leveraged well past 160% of their annual gross income in debt, I think it’s time to we stop the “Gravy Train” as Rob Ford would say.

The average Canadian won’t know much about investing.  That’s why it’s important that we shouldn’t fall into corporate marketing traps of borrowing money to invest.  In the long run, we’ll end up buy mutual funds or gambling on the stock market through day trading.  Our investments will perform poorly and our rate of return will be paltry.  Most of us can’t take the risk of paying interest on loans without the guarantee that our own investments can beat that interest rate.

If you’re thinking about borrowing more money. Don’t.  It’s better to begin budgeting for next year.  Rather than trying to make a lump sum payment for your RRSP, why not consider doing a pre-authorized payment of $50/month towards your RRSP? There are much better strategies that one can use to make contributions without falling into more debt.

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