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By Sharon Adams,
CanWest News Service
“RRSP Extra” Section
Wednesday, February 15, 2006
Published in:
The Vancouver Sun
Edmonton Journal
Saskatoon Star Phoenix
Montreal Gazette
Ottawa Citizen
The March 1 deadline for RRSP contributions makes February crunch month for many Canadians. It's tempting to use accrued contribution room in a registered retirement savings plan to build a bigger retirement nest egg, but where to get the cash?
Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "The key is to take the rebate and plow it back against debt, and pay it off quickly.”
"I have clients paying a healthy marginal tax rate, with not a lot of cash available," says Adrian Mastracci, president of KCM Wealth Management Inc. in Vancouver, a fee-only investment and financial advisory firm. "But they have borrowing capacity."
Borrowing to catch up on RRSPs can make good sense over the long term, allowing investors to maximize tax refunds, keep their household budget operating and build towards retirement.
Canada's six million taxpayers contributed $28.8 billion to RRSPs in 2004, collectively using only eight per cent of the more than $360 billion of allowable contributions, according to Statistics Canada. Only 30 per cent of Canadians contributed to their RRSPs, although 87 per cent of tax filers were eligible.
Luckily, current rules allow us not only to make an annual tax deductible contribution to our RRSPs -- to a limit of 18 per cent of the previous year's earned income to a fixed maximum of $16,550 -- but also to carry forward unused contribution room from year to year.
The maximum contribution has gone up by $1,000 each year since 2002 and unused room represents lost tax savings and smaller nest eggs. Borrowing to maximize RRSP contributions can help investors meet their long-term savings goals, but not everyone should borrow.
On a personal level, "it's always 'the higher your tax rate, the better the strategy to borrow,' " says Jean-Remy Deschenes, financial communication adviser, wealth management services, for Desjardins Group of Quebec.
But whether to borrow, when to borrow and how much to borrow varies with the personal and financial characteristics of individuals. An investor's comfort level with risk is a major factor.
Borrowing money to invest is called leveraging. Investment advisers hold out the carrot of increasing returns by as much as 50 per cent over the long term. But just as leveraging can multiply gains, it can also magnify losses -- not something many conservative RRSP investors can tolerate well.
When the markets boom and interest rates fall, leveraging pays off with impressive gains. But when markets fall and interest rates rise, nest eggs can shrink. While the fund is likely to recover over the long term, nervous investors react immediately to ups and downs in their portfolios and may find it intolerable to be on the hook to pay for a loan on an investment that is tanking, even if only for the short term.
Catch-up borrowing is not for the investor who dislikes risk or uncertainty. And with interest rates at a 40-year low, the only thing that looks certain is they're likely to rise. If these investors borrow at all, it should be for amounts that can be paid back within a year. "The key is to take the rebate and plow it back against debt, and pay it off quickly," says Mastracci.
For example, says Deschenes, a $5,000 RRSP loan at a five-per-cent interest rate will cost $250 monthly to support. If you're in a a 40-per-cent tax bracket, you would get a $2,000 tax refund. If you put the refund against the loan, the rest could be paid off within 12 months.
Investors with large mortgages, car payments, or large lines of credit should consider reducing their debt first. "The key to getting out from under the debt monkey is to pay off debt as soon as you can," he says. While it's true that compound interest is what makes your RRSP fund grow, compound interest is also being charged on mortgages, typically Canadians' largest debts. Paying down the mortgage faster may save you more money than those funds would make over the same time in your RRSP.
Finally, "if you are borrowing for your RRSP close to retirement, you're not doing proper planning," says Mastracci.
Deschenes disagrees, noting three trends over the past five years that make catch-up RRSP borrowing attractive even for those approaching retirement.
First, RRSP savings are critical for the "60 per cent of all Canadians [who] don't have [private] pension plans," says Deschenes, and fewer and fewer companies are offering this expensive benefit.
Second, Canadians are living longer. "When you retire at age 60 you can expect to live 20 to 25 years. The inflation rate is two to 2.5 per cent. You have to ask yourself what $1,000 will be worth in 25 years time."
Third, costs for health services are skyrocketing.
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