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Why an RRSP Loan is Not a Bad Idea

Maximizing your annual RRSP contribution is a good way to build a secure retirement. But what’s more appealing is the benefit you see right now. Your contributions to your RRSP reduce your taxable income, and in turn, can save you from paying more income tax than you have to.

Sounds pretty good, right? As we all know, it can be tough to come up with a lump sum of money if you haven’t made any contributions throughout the year.

Most financial institutions offer an RRSP Loan. The interest rate on this type of loan varies, as does the amount you can borrow, but most allow a minimum loan amount of $5000 up to a maximum of about $50,000, and currently rates may be around 5%. RRSP loans are generally paid back in monthly installments over a term of 1 month – 5 years.

Say your marginal tax rate is 20%. Borrowing $5000 for a term of 1 year at 5% will save you $1000 in income tax, and will only cost you $136 to borrow over the term. What’s more is your RRSPs earn you interest as well. If you’re really smart, you’ll apply the $1000 in tax savings directly to your loan and reduce the time to pay off the loan from 1 year to 10 months, which in turn cuts back the cost of borrowing to about $105.
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