Borrowing for TFSA or RRSP Contributions: A Calculated Risk Analysis
As promotional offers for registered retirement savings plan (RRSP) loans become more prevalent, many Canadians are contemplating whether borrowing to fund their TFSA or RRSP is a financially sound strategy. While leveraging debt for retirement planning can appear attractive, particularly for higher-income earners, it is crucial to thoroughly understand the inherent risks involved.
Understanding Leveraged Investing in Registered Accounts
Borrowing to invest in a tax-free savings account (TFSA) or an RRSP is fundamentally no different from other forms of leveraged investing. This approach amplifies both potential gains and losses, requiring investors to carefully assess their risk tolerance and financial discipline. The decision hinges on several key factors: the specific plan being targeted, anticipated investment returns, individual risk appetite, and the borrower's commitment to repaying the loan.
TFSA Borrowing: Potential Returns Versus Costs
With TFSAs, if investments perform well, returns could potentially surpass borrowing costs. For instance, consider borrowing $7,000—the annual contribution limit—to maximize a TFSA in 2025. If those funds were invested in an exchange-traded fund (ETF) tracking Canada's major bank stocks, the total return could reach approximately 43 percent. This would significantly outweigh a borrowing cost slightly above prime, typically around five percent.
However, this strategy essentially constitutes leveraged investing, which increases financial risk. Losses can be magnified just as easily as gains. Ultimately, investors are betting that their expected after-tax investment returns will exceed the interest rate on the loan. There are no official statistics on how many Canadians borrow to invest in TFSAs, but unused contribution room remains substantial across the country.
RRSP Loans: A Different Financial Calculus
RRSP loans present a distinct scenario with their own logical appeal. The process is straightforward: borrow to make a substantial contribution, use the deduction to reduce taxable income, receive a tax refund, and then apply that refund toward loan repayment. On paper, this strategy appears effective.
Most Canadian banks offer specialized RRSP loans with flexible repayment terms at rates hovering near the Bank of Canada's prime rate, currently 4.45 percent. For example, Royal Bank of Canada provides RRSP loans of up to $50,000 specifically designed to help clients catch up on missed contributions from previous years. These loans feature rates as low as prime with repayment periods ranging from one to ten years. Similarly, Canadian Imperial Bank of Commerce offers a limited fixed rate of 3.49 percent for loans up to $75,000, also with ten-year repayment options.
Expert Perspectives on RRSP Borrowing
Shawn Stillman, co-founder of Mortgage Outlet Inc., notes that banks often aggressively promote RRSP loans during this season. He suggests that such loans can be sensible for individuals who haven't contributed for several years, have accumulated unused contribution room, and are experiencing a high-income year. If the loan structure permits, borrowers can make lump-sum payments when their tax refund arrives, accelerating repayment.
However, a critical tax consideration remains: interest paid on loans for investments within registered accounts like TFSAs or RRSPs is not tax-deductible. This deduction only applies to interest on loans used for investments in non-registered accounts or property, making the cost of borrowing for registered accounts effectively higher after taxes.
Weighing the Risks and Rewards
While borrowing to maximize registered account contributions can accelerate retirement savings and potentially enhance returns, it is not without significant risk. Market volatility, changing interest rates, and personal financial circumstances can all impact the outcome. Investors must conduct thorough due diligence, possibly consulting with financial advisors, to determine if this leveraged approach aligns with their long-term financial goals and risk tolerance.
