RRSP: How a second mortgage can make your RRSP contribution more profitable
February may be the shortest month of the year, but it can also be the most profitable if you take advantage of it to contribute to your RRSPs before the deadline (March 1, 2022, for the 2021 tax year). There are several options that let investors maximize the many short- and long-term tax benefits of this type of registered account.
Taking out a second mortgage is one option that can help you make the maximum RRSP contribution. This is a highly profitable strategy that any homeowner can take advantage of. But before we look at this course of action, let’s review the main advantages of RRSPs.
What are the benefits of an RRSP?
1. Reduce your tax bill
The money you put into your RRSP is tax deductible. In Quebec in 2022, someone with a taxable income of $50,000 to $85,000 for the previous year will receive a tax deduction of $371 just by contributing $1,000 to their RRSP (marginal tax rate of 37.12%).
The higher your income, the more the RRSP becomes an advantageous investment vehicle. If your taxable income is higher than $160,000, which brings your marginal tax rate to over 50%, then the governments will deduct half your RRSP contribution.
2. Grow your money, tax-free
The money in your RRSP is not taxed so long as it stays in the account. Only withdrawals are taxed. Since your taxable income after retirement is substantially lower, so is the marginal tax rate. Therefore, you not only benefit from a tax break during your working years, you also get to fully enjoy the power of compound interest, since RRSP gains aren’t negatively impacted by taxation for a long time.
Also noteworthy is the fact that the Lifelong Learning Plan (LLP) and Home Buyers’ Plan (HBP) let you borrow from your RRSP to finance studies or the purchase of your first home.
The important thing to remember is that, in most cases, for salaried employees but also for many entrepreneurs, the RRSP is a fiscal tool whose financial advantages are too generous to overlook.
Is it a good idea to borrow money to make an RRSP contribution?
Yes. It’s a purely mathematical decision: If the interest rate on the financing is lower than the overall rate of return you’ll get from contributing to the RRSP, then it’s worth borrowing money to make that contribution.
Why take out a second mortgage to make an RRSP contribution?
While it’s often worth it to borrow money to contribute to your RRSP, it can be difficult for some people to get financing from conventional financial institutions.
Here’s an example:
Audrey got a big promotion at the beginning of 2021 and her taxable income for the year was $120,000. She took advantage of the raise to pay back her credit card. Then she had a large unforeseen expense in January 2022. This considerably reduced the amount of cash she has on hand to contribute to her RRSP before the March 1st deadline.
Because of her high salary, Audrey is taxed at close to 32%. And her marginal tax rate (the rate she pays on every additional dollar of income) is over 47%.
Fortunately, she can contribute up to $21,600 to her RRSP (18% of her salary), which substantially reduces her tax bill.
She decides to borrow $20,000 to benefit from the high contribution ceiling and pay less in taxes.
Given that she had accumulated several late payments in 2020, her credit rating is still too low to meet her bank’s criteria. She goes to a private lender to get a second mortgage. Since the loan is based on her house’s net value, she quickly obtains the amount, which she puts into her RRSP.
This contribution gets her a tax refund of $9,400! She uses this amount to pay back close to half her loan.
She ends up with $20,000 more in her retirement savings, an amount that will generate a lot of interest over the years. The balance of her loan is already under $11,000. Assuming a normal return on her savings and a standard interest rate, the real cost of her loan will end up being negative.
In other words, this loan will have made her money. Borrowing to contribute to your RRSP is a financial lever that’s accessible to everyone!
