Why Borrowing to Invest in RRSP is a Bad Idea?

RRSP season is coming.

You still have two more months to top up your RRSP contribution. If you have fully used up your RRSP contribution room for 2009, your 2010 RRSP contribution limit will be 18% of your 2009 earned income to a maximum of $22,000. You might have more contribution room if you have unused RRSP from previous years.

RRSP is a tax deferred investment. You do not pay any tax on your RRSP contribution as long as you keep your investment in your RRSP account. Once you start to withdraw money from your RRSP account, it become fully taxable during the year it is withdrawn, except for Home Buyer Plan. HBP is like taking a loan from your RRSP account and you must pay it back. If you do not repay and fill up your RRSP account, unpaid amount is included in your income and is taxable.

If you have room in your RRSP, your financial planner or institution will probably advise you to take a loan and deposit the money in your RRSP account.

It might be a good business strategy, if you plan to keep your RRSP account for the next 20 years.

From my experience, what I have seen is, that anyone taking a loan to top up their RRSP contribution, eventually liquidate their RRSP account in less than five years. Once liquidated they become responsible to pay taxes on the RRSP money they borrowed in the first place.

So the taxpayer first pay interest on the bank loan and then pays tax on the loan too. A bank loan is not an income and is not taxable. But by converting the loan into RRSP and then liquidating the RRSP funds, they simply make the loan a taxable income.

Also keep in mind, interest expense to borrow money to invest is tax deductible, but the interest to borrow money to invest in RRSP is not.

Usually it cost a taxpayer thousands of dollars in after tax money, to borrow money to invest in RRSP and then liquidate the RRSP account. Many taxpayers follow this strategy with the advice of their banker.

I suggest, review your financial situation first, if you can keep the RRSP account for the long term. If not, do not borrow, just to fund your RRSP.