FINANCIAL ADVICE FOR CANADIANS
If you're having trouble coming up with the money for this year's Retirement Savings Plan (RSP) contribution or you've got unused room from previous years, borrowing can be smart. Many financial institutions offer RSP loans and with interest rates very low right now, borrowing to maximize your contribution usually makes good dollars and sense - here's why.
The value of a top-up loan:
• Your RSP offers such generous tax savings and tax-deferred growth potential that the short-term interest costs of borrowing are far outweighed by the long-term benefits. Let's say you're entitled to make a maximum RSP contribution of $10,000 for the 2003 tax year but you've only got $5,000 in your savings account. You could borrow the extra $5,000 and pay it back in a year at an assumed interest rate of 7%.
• If your marginal tax rate is 35%, that additional $5,000 contribution gets you an immediate tax refund of $1,750. And if your RRSP delivers an 8% return over the next year, your $5,000 top up will earn you an additional $400 inside your RSP.
• But you have to also consider the cost of borrowing under your loan. For a one year loan, at 7%, that adds up to just over $190 in interest charges, assuming that the loan is being re-paid on a monthly basis.
• For the cost of just over $190 in interest plus the principal re-payment of $5,000, you end up with $5,400 in your RSP (the $5,000 contribution plus the $400 earned in tax deferred growth over the year) and an extra $1,750 in tax savings. You are thus ahead by $1,960.
• However, making this even more compelling, if you leave that additional $5,000 in your RSP for 25 years, and the RSP grows at an average rate of 8% per year, the contribution will grow to more than $34,000. The same principles can be applied to a "catch-up" loan. If you were unable to make your maximum RSP contribution in previous years, the rules allow you to 'catch up' in any taxation year. One way to do this is to take out a larger, 'catch up' loan and most institutions offer special RSP loans for this purpose that can take up to ten years or more to repay. It's easy to see that borrowing may be a smart way to maximize this year's RSP contribution or to catch up on your unused contributions from previous years - but only if you follow these tips:
• Look for low interest rates. Make sure the cost of borrowing does not eat up your potential tax and investment returns. And remember that the interest paid on RSP loans is not tax-deductible.
• Keep the term short. For top-up loans, limit the payback schedule to one or two years. For more sizable catch-up loans, it is best in most cases that the term not exceed five years.
• Use your tax refund to pay down the loan. You can reduce the burden of monthly loan payments, loan costs and the length of the loan by using your tax refund to pay down your loan. Most financial institutions will allow you to defer your first RSP loan payment for up to four months -- depending on when you take out your loan, your first loan payment may not need to be paid until you get your tax refund. Your financial advisor can help you structure RSP loans for maximum tax benefits now and maximum investment savings for your retirement.
This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice.
For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.
In Toronto, contact Sally Brady
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