Author Topic: Borrow into Line of Credit to Buy RRSPs?  (Read 1432 times)

drone

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Borrow into Line of Credit to Buy RRSPs?
« on: January 21, 2016, 01:50:23 PM »
Long time lurker, first time poster.

I live in Canada, am self employed and had an excellent year last year, almost doubling my income.  However as a family we had a huge year of untracked spending, horrifying us when we realized.  Now we are chastened, seeing that frugality really really means freedom. 
  In order to reduce the tax bill, I'd love to max out my RRSP, whose limit is $75,000 this year. (Oh how I wish I could go back into my twenties and buy RRSPs instead of bikes and stereo gear and climbing gear.)  I'd need to borrow $40,000 from a 3.7% flexible rate interest only LOC.  I reckon we can pay this off completely in two years, even with maxing contributions for next year and covering mortgage payments.  Good idea? (if markets were more cheerful I think it'd be a no brainer, but....)
Thanks for any thoughts...

DividendMoney

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Re: Borrow into Line of Credit to Buy RRSPs?
« Reply #1 on: January 21, 2016, 02:04:25 PM »
Long time lurker, first time poster.

I live in Canada, am self employed and had an excellent year last year, almost doubling my income.  However as a family we had a huge year of untracked spending, horrifying us when we realized.  Now we are chastened, seeing that frugality really really means freedom. 
  In order to reduce the tax bill, I'd love to max out my RRSP, whose limit is $75,000 this year. (Oh how I wish I could go back into my twenties and buy RRSPs instead of bikes and stereo gear and climbing gear.)  I'd need to borrow $40,000 from a 3.7% flexible rate interest only LOC.  I reckon we can pay this off completely in two years, even with maxing contributions for next year and covering mortgage payments.  Good idea? (if markets were more cheerful I think it'd be a no brainer, but....)
Thanks for any thoughts...

In a way it is a good thing that you amassed such large RRSP room if you are now earning significantly outsized personal income compared to your prior year's income(s). 
The answer to your question really depends on whether you think you will have large income in the next few years before retirement.
Do the tax math and see what you need to bring yourself to the top of the lowest tax bracket. Any further and you're not really gaining/saving much - the RRSP room is likely better used in future high earning years.  But, you have to do the math or have an accountant do it for you.
« Last Edit: January 21, 2016, 02:05:57 PM by DividendMoney »

ooeei

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Re: Borrow into Line of Credit to Buy RRSPs?
« Reply #2 on: January 21, 2016, 02:05:34 PM »
Since your income doubled last year, I'm a bit skeptical as to how predictable and stable it is.  Taking out debt to invest is always a risk.  Combine that with the fact that you haven't actually lived this more frugal lifestyle you assume you'll enjoy.

As a quick "worst case scenario exercise:  What happens if you take the loan and your income is cut off 3 months into the year and the market has dropped 50%?  This could be from a medical issue, competition, or any number of things depending on your business.  Can you continue paying all of your bills in this scenario?  If you have a lot of saved money, maybe you can and the risk is worth it to you.  If not, I'd just make note of this year as a mistake and be sure to max out from now on.

edit: Based on the above comment it seems there's some sort of lifetime limit to RRSP?  I assumed it was like a 401k with an annual limit, so that changes things.
« Last Edit: January 21, 2016, 02:07:12 PM by ooeei »

drone

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Re: Borrow into Line of Credit to Buy RRSPs?
« Reply #3 on: January 21, 2016, 02:56:12 PM »
Thanks for the replies. That is a good reminder that my income can change, depending on the year.  I'm a beekeeper, so it all has to do with three things: weather, bee health and the price of honey.  Only one of those I can control.  That said, the 20 year average in my area has been quite steady, with only a few years really high or really low.  I think I'm comfortable borrowing only as much as we can afford in a poor year.  My wife has a steady 9-5 so that is a bit of a buffer. 

Re: "Do the tax math and see what you need to bring yourself to the top of the lowest tax bracket. Any further and you're not really gaining/saving much - the RRSP room is likely better used in future high earning years."

I've never fully understood this: If contributing to rrsp brings me from a 36% tax bracket to a 30.5% bracket, don't I continue to enjoy 30.5% savings in tax right down to the next bracket and so on, as my contributions bring my tax payable down directly?

Re: "Combine that with the fact that you haven't actually lived this more frugal lifestyle you assume you'll enjoy."

Well said - I think it will be an ongoing challenge, one (I think that) I'll be happy to embrace but my wife is more skeptical about.



TrMama

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Re: Borrow into Line of Credit to Buy RRSPs?
« Reply #4 on: January 21, 2016, 04:18:18 PM »
Two things give me serious pause about your plan:

1. You have not yet lived with the more frugal budget. Reducing spending is a lot like dieting. Some people take to it right away with no trouble. Others struggle for years. No way to tell which way you'll go until you try it.

2. Current market volatility. If your interest rate is 3.5% and whatever investment product you buy loses value, will you really be better off in the long run? What if it tanks more than the amount you saved on taxes?

If you do decide to go ahead with the plan, I'd only borrow a small amount to use as a learning tool. A better strategy would be to start making regular RSP contributions now that will be used against your 2016 taxes. Alternatively, is there anything you can sell before the cutoff date to give you some cash to stuff in the RSP?

okits

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Re: Borrow into Line of Credit to Buy RRSPs?
« Reply #5 on: January 21, 2016, 07:13:54 PM »
What is your expected tax bracket when you foresee withdrawing money from your RRSP (compared to now)?  Just because you have $75k in contribution limit doesn't mean applying it all now is optimal.

And remember: you are not "saving" taxes by contributing to your RRSP, you are deferring the tax liability to a future date when hopefully the applicable tax rate is lower. 

I share others' uneasiness with you borrowing to invest.  If you doubled your income last year and still don't have the cash on hand to contribute to your RRSP, you're proceeding on hope alone (not a proven track record) that you'll repay the loan in a timely manner. 

If you are seeking to reduce the amount of a current tax bill (rather than receiving the deferred taxes as a refund) I am even more concerned.  Say you borrow $50k for your RRSP and receive an $18k cheque for the deferred taxes as a refund.  In this case you use the $18k to reduce your debt from $50k to $32k, reducing interest costs and the amount you need to repay from regular income.  But if the $18k refund simply serves to reduce the amount of tax owing, you still have the $50k debt to pay off (plus interest costs) unless you have the discipline to carve the $18k of deferred taxes out of somewhere else in order to reduce the debt.

Your wife's scepticism/resistance is a warning flag.  I do see the benefit from your plan if everything works out for the best.  But in your current situation it sounds risky.