Dear Canadians, it’s the RRSP season and you probably must have heard about RRSP loans. I understand it can be confusing. What's an RRSP loan? Do you need it? Should you take it if offered? Here’s all you need to know about RRSP loans. A thread.
RRSP contributions allow you to lower your taxable income. When you are filing your taxes for the year, your RRSP contributions are used to work out your new tax bracket and that might result in you getting more tax refunds. Who doesn't want more tax refunds?
An RRSP loan is a strategy to reduce your tax bracket by getting a loan from a financial institution, contributing the loan into an RRSP account, and hereby reducing the taxable income. Sometimes, get more tax refunds and use the refunds to pay back the loan.
An example: Tom is a consultant in Ontario. He earned 200k last year, he is in the 37% tax bracket. He has a 20k RRSP contribution room but only contributed 4k. Tom has a 16k room balance but he cannot afford 16k due to the high cost of living.
Tom knows that by the time he files his taxes, he will need to pay the government more money in taxes. He doesn’t want to do that so he decides to get a 16k loan and uses it to max out his RRSP contribution room. Tom reduces his taxable income, which saves him some money in taxes
While an RRSP loan might sound like a great idea, it’s important to note that it’s a loan, with interest rates and most times they use the bank's prime interest rate. That’s a debt. To make it easy for you, some banks defer your first payment by 90 days.
In my opinion, RRSP is encouraged if you can contribute in high-income years and withdraw in the future in low-income years as your tax bracket at withdrawal is a factor to consider. If you are in a low tax bracket, and you have not maxed out your TFSA, focus on your TFSA first.
However, if your income was extraordinarily high last year due to multiple jobs, bonuses, and contracts, an RRSP loan might be a better option for you but do your maths, and calculate your compound interest on the loan for the amortization period, is it worth it?
Talk to a financial advisor, don’t just jump on an RRSP loan offer. Don't complicate your finances in a bid to earn more tax refunds. Everyone’s situation is unique, be sure it’s worth it for your situation.
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