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The Fund Library publishes Samantha Prasad's "Should you borrow to invest in your RRSP?"

Jan 23, 2017

 Should you borrow to invest in your RRSP?

The deadline for 2016 contributions to your Registered Retirement Savings Plan (RRSP) is March 1, 2017, so you don’t have much time to make a decision. Those who wait to the last minute instead of contributing regularly through the year often skip the contribution because they can’t find the funds, but that need not be the case. Last time, I suggested looking at contributions in kind or retiring allowances as sources for funds. But there are also other options to consider, including borrowing the money and reducing source deductions.

Should you borrow to make an RRSP contribution?

Borrowing to invest in an RRSP might seem counter-intuitive to most people. Why not use the funds to pay down your mortgage instead? When you think about it, though, by making an RRSP contribution instead of paying down your mortgage, you are in effect borrowing to contribute to your RRSP – that is, by leaving your mortgage outstanding.

So borrowing may make sense if you think you can make a better return on your RRSP than the interest you pay, especially if you expect your tax bracket to drop when you retire (this includes borrowing to make a catch-up contribution). In figuring whether your tax bracket will drop after retirement, watch out for hidden taxes, such as Old Age Security and other items that are subject to “clawbacks” as income increases.

Although there is something to be said for borrowing to contribute, it is not necessarily at the top of my list. Yet the big marketing push by some financial institutions at this time of the year would lead you to believe that it’s a no brainer. But much of that advertising focuses on your short term-position – leaving out the tail-end tax effects of the RRSP loan gambit, thus conveniently omitting the biggest downside of the strategy.

The bottom line is that while this may not be a bad idea if you can pay down your loan in the not-too-distant future, longer-term loans may not make much financial sense unless you are confident you can sustainably earn more on your investments than your ongoing interest charge. As this generally rules out interest-bearing investments, it means you’re levering yourself up in the hope that your mutual fund or equity returns will defray your interest charges, and then some. But as we know, equity investments are getting up there on the risk scale – particularly if levered. By levering your RRSP nest egg on a long-term basis, you’re betting the farm, which is usually not a good strategy.

Slash your source deductions

Another source of cash for RRSP contributions could be the source deductions withheld on your paycheque. Many people regularly get tax refunds because of deductions such as support payments, carrying charges on investments, and so on. While this may give you a good feeling when you file your tax return, the truth is that you have really been lending the government your money on an interest-free basis. In fact, by the time you get your refund, the Canada Revenue Agency might have had the use of your money for up to a year and a half — money that could come in handy this time of year to pay for holiday spending, winter vacations, and the like.

If you’re in this situation, simply fill out Form T1213, which can be found on the Canada Revenue Agency website, and file it with the Client Services Division of your local CRA Tax Services Office. If the feds approve your request, they will notify you in writing, which will take four to eight weeks (note that the CRA will most likely not approve your request if you owe tax or have a tax return that is overdue for filing). Once you receive written notification, present it to your employer, who should then reduce withholding tax accordingly.

You usually have to file this request every year. However, if you have deductible support payments that are the same or greater for more than one year, you can make this request for two years.

Most tax offices are quite cooperative when it comes to this procedure. According to the CRA, there is no specific minimum amount below which they will not consider an application. (Occasionally, the personal exemptions on which your source deductions are partly based may change. If so, you should fill out Form TD1 with the revised exemptions and give it to your employer who will adjust your source deductions in accordance with the revised information – in this case, CRA approval is not required.)

One item that may get you a source-deduction slash is an early RRSP contribution for 2016. Contributing early in the year also means your earnings will compound tax-sheltered sooner rather than later.

One word of warning, though. If your refund is based on something you don’t want the feds looking at, you may want to think twice before you apply for a source-deduction cut. It is possible that your application could result in scrutiny of the items on which your claim is based. So if you are making aggressive claims, it may be best to leave well enough alone.

Consider an advance on your inheritances

It’s worth noting what you should do if you receive an advance on an inheritance as a gift rather than a loan, and you are married when this occurs. If this is the case, the advance should be documented, so that the gift, and subsequent income earned on it, are not subject to a spousal claim in the event of marital difficulties.

Previously published in The Fund Library on ​January 23, 2017 by tax and estate planning lawyer, Samantha Prasad.

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