Take out a loan to maximize an RRSP?
The deadline for 2011 RRSP contributions is Feb. 29. It's officially RRSP season and along with that comes the annual debate about loans: Should you or shouldn't you.
Visit a financial institution, watch TV or open any newspaper and the overwhelming message is "yes," as lenders shift into high gear, flogging RRSP loans and their benefits.
The big sell
In addition to the big one — tax-deferred growth within their RRSP — people are also drawn to the idea of garnering a larger tax refund by maximizing contributions; the pitch being you can use the refund to pay back part of the loan.
The pressure is on to maximize investments and tap into unused contribution room. Those bar charts on the websites and in the ads depicting the power of compound interest are pretty convincing, especially when illustrating how that $30,000 investment loan will grow in 10, 20 or 30 years, as compared to the $5,000 investment you can afford out of pocket.
But if you read the fine print — the part that says growth rates are for illustrative purposes — it can raise questions. In fact, if you take a look at broad stock market returns for 2011, Canada was - 12 per cent (U.S. was + two per cent) and many funds underperformed the overall market, according to Zacks Investment Research.
If you borrowed $30,000 to invest this time last year, it could be down $3,600 or more, not to mention interest costs. As for safe havens like GICs, returns are at all-time lows.
Will it pay off?
Does it pay to borrow to invest? Kathryn Del Greco, VP, investment adviser at TD Waterhouse Private Investment Advice, thinks it does: "You can't focus on these short-term returns. You have to think long term." She believes over time investors can expect a minimum six per cent return each year. Plus, with low interest rates, borrowing is cheap.
Lenders sweeten the pot with deferred payments for 90 to 120 days (though in most cases interest is still accruing, you just don't have to make a payment), and amortization of up to 15 years.
Most offer various products, but RRSP loans generally boil down to two types: short-term top-up loans and long-term catch-up loans. Is one right for you?
There's no easy answer, says Michael Thorne, a CFP professional with Thorne Financial Services in Vancouver. "It totally depends on the person's individual financial situation at the time — it always comes down to crunching numbers."
And, there's risk. Borrowing to invest in an RRSP is a form of leveraging. "If you're borrowing money and it doesn't grow by more than the interest you're paying, then you're losing money," says Thorne, adding in today's climate he recommends a cautious short-term approach.
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