RRSP Loan: Benefits and Drawbacks

An RRSP loan lets you borrow money to contribute to your RRSP. This strategy can help you lower your taxable income and potentially get a tax refund, but it isn't right for everyone.

A registered retirement savings plan, or RRSP, is a tax-deferred account in which you can save and invest for your retirement. Contributing to an RRSP lowers your taxable income, which could result in a tax refund.

Participating in an RRSP can be a smart tax strategy, but not everyone has extra funds to contribute. Fortunately, many banks offer a tailor-made solution: an RRSP loan. Here’s how an RRSP loan works and how to decide whether using one might be right for your situation.

What is an RRSP loan?

An RRSP loan allows you to borrow money for the specific purpose of contributing to an RRSP. Since this is a loan, you’ll pay interest on the money you borrow.

Because RRSP contributions lower your taxable income, they may reduce the taxes you owe for the year, potentially resulting in a tax refund.

Hypothetically, you’d use your potential tax refund to pay off part of your RRSP loan as soon as possible. You would then make payments on any remaining loan amount over the term.

Where to get an RRSP loan

Financial institutions typically offer two types of RRSP loans:

Short-term RRSP loan: Typically a smaller amount you can contribute to your RRSP right away, with a term of around 12 months.
Long-term RRSP loan: Offers a larger sum so you can catch up on RRSP contribution room from previous years, often with terms of up to 10 years.

How to qualify for an RRSP loan

Each lender has different eligibility criteria for RRSP loans, but generally, they’ll look at the following:

Credit score. You’ll likely need a good credit score (around 660) to be considered for an RRSP loan.
Income. Lenders will need to see that you have the ability to repay your loan.
Existing debt. How much debt you currently have could affect the size of the RRSP loan you’re offered.

To apply for an RRSP loan, you’ll typically need to speak with a representative over the phone or in person at a branch, though some banks offer online applications. Most major financial institutions and even some online-only banks offer RRSP loans.

Reasons to consider an RRSP loan

RRSP loans are appealing for two simple reasons. First, contributing to your RRSP means you’ll get an immediate tax break. Second, the contribution has long-term growth potential, depending on your investment strategy. Generally, if the growth in your RRSP is more than the interest you’ll pay, the loan can make good financial sense.

For example, let’s say your income puts you in the 40% tax bracket. So far this year, you’ve made an RRSP contribution of $1,000, but you have $4,000 contribution room left. You take out a short-term RRSP loan to max out your account, which results in a tax refund of $2,000.

(Note: We’ve used a simplified refund amount for this example. Any potential refund will depend on factors like income, province or territory of residence, and other tax credits and deductions.)

If you apply your refund to your loan, you’ll need to pay back $2,000, plus interest, over the next year. If you’re paying 4% interest for the loan, but your investments generate more than that, you’ll come out ahead.

Contributing to an RRSP is also beneficial since it gives you a tax deferral. The idea is that you’ll contribute during high-income years, when you’re in a higher tax bracket, and get a tax break. When you eventually withdraw the funds in your retirement years, you’ll hopefully be in a lower tax bracket. This strategy aims to reduce the overall amount of tax you pay over the course of your life.

Benefits and drawbacks of RRSP loans

Despite its benefits, an RRSP loan may not be an ideal solution for everyone. Like most methods of borrowing money, RRSP loans have both pros and cons, and it’s important to understand them before applying.

Benefits of an RRSP loan

Tax breaks and growth. Contributing to your RRSP gives you a tax deduction and the opportunity for long-term growth.
Flexible limits. Many financial institutions allow you to borrow up to $50,000 so you can use the funds for the current year or to catch up on missed contributions from previous years.
Flexible terms. The term of the loan is usually between 1 to 10 years.
Deferred repayment. Most RRSP loans don’t require you to start repaying funds for 90 days, which should give you enough time to get your tax refund.
No prepayment charges. You can usually repay more than your fixed amount at any time without incurring any penalties, allowing you to pay off the loan faster and save on interest.

Drawbacks of an RRSP loan

Savings may be limited. If you’re not in a high tax bracket, the amount of money you’ll actually save using an RRSP loan may be minimal.
No guarantee of higher returns. The investment returns you make need to outpace the interest you’re paying to make an RRSP loan worthwhile.
Can only be used for RRSPs. Focusing on your RRSP doesn’t make sense if you have outstanding high-interest debt, such as credit card debt. It’s a better idea to pay off that debt first before borrowing more money to invest.
It’s another form of debt. Even when used strategically, an RRSP loan is still another debt that requires payments. Consider why you’re confident that you can fit these payments into your budget going forward if you couldn’t make regular contribution payments over the past year. It might be better to add regular RRSP contribution payments to your budget instead of required debt repayments.

Is an RRSP loan worth it?

When the math works out, RRSP loans can be a way for someone without much cash on hand to maximize their contributions. That said, the tax benefits mainly help high-income earners since they’re in a higher tax bracket.

In addition, not only do your investments need to outpace the interest rate you’re paying on an RRSP loan, but you also need to make sure the payments fit into your budget without hurting your cash flow too much. If debt repayment is a concern for you, it might be better to focus on making regular RRSP contributions instead.

If you think an RRSP loan might be a good option for you, consider speaking with a certified financial planner to understand the benefits and drawbacks for your unique situation.

An RRSP loan allows you to borrow money for the specific purpose of contributing to a registered retirement savings plan.

Yes. As with any bank loan, lenders will typically look for RRSP loan borrowers to have a credit score of 660 or above.