Use line of credit for RRSP?
Q – I have a fully open line of credit at 7.5% interest which I have $ 24,000 to repay. My maximum RRSP contribution for 2000 is $ 9,000. Is it to my advantage to use $ 9,000 from the line of credit to maximize my RRSP contribution for this year and use the money I get back from the income tax deduction to repay the line of credit?- L.D.O.
A – Normally I don’t advise borrowing to invest, but an RRSP contribution is a different matter, for two reasons. First, the tax refund, which can be used immediately to reduce the principal on the loan. Second, the tax-sheltering aspect of the RRSP investment.
When you do the math, the return in the first year is excellent. If you are in a 40% tax bracket, the $9,000 contribution will produce a refund (or a reduction in tax payable) of $3,600. If you invest the money within the RRSP to each 7% over the next year, that adds another $630. Total return is therefore $4,230, or 47% on a $9,000 investment. Pretty compelling.
Of course, you have to subtract the interest payable from that, but at 7.5% that works out to only $675 over one year, assuming you did not use the refund to pay down the principal – whichou intend to do.
However, remember that interest on an RRSP loan is not tax deductible. Also, you should aim to pay off the full $9,000 over the next 12 months because after that the math starts to deteriorate (no tax refund in year two to boost your return). – G.P.