# RRSP Loans: is borrowing to invest worth it?

Welcome back to Drawbridge

Finance. today we’re talking about RRSP loans. Hey Everyone welcome back my name is

Levi woods. I’m not a professional investor, I don’t work in the financial

industry and this is an opinion channel about money. Today, I want to talk to about RSP loans and this is a pretty touchy subject because basically the theory behind RRSP loans is that you borrow money and then invest it. Now you can invest in a guaranteed investments certificate and make a guaranteed return. Usually that return is less than the amount

of interest that you’re paying on the loan so it’s a it’s difficult to get those guaranteed investments to pay more than the interest. It doesn’t

usually work out so what most people do is they invest in the stock market or

they invest in an ETF that’s going to potentially return an average rate of

return that’s greater than the amount of the cost of the loan. If we could

get a loan for four and a half or four and three-quarters percent but we

know that the S&P 500 returns around seven point eight percent on average per

year then in theory the the loan will cost us less than the returning the

investment now RRSP loans are interesting RRSP Loans are available to Canadians

and what they do is they allow the borrower to borrow money to invest

specifically into their RRSP before the RRSP deadline of the end of February. What this does is it increases the amount of refund that they get when they do

their income tax. Now RRSPs are not the best financial vehicle

because we eventually have to pay that tax in the future so it’s something to

take into consideration what the marginal tax rate actually is and I’ll

cover that in this video but what what it allows people to do is start

investing without actually having any money right now today for for myself I

actually did this I have taken two RSP loans in my life because when I was

young I knew that I needed to start investing they were not well kind

because I was invested in the broad market we know that we had the dot-com

crash in the 2000s 1999 mm and I lost a substantial amount of

that money that I had borrowed to invest so I know firsthand that this is is a

risky thing to do but what that did was it set me on a path that I continued for

the rest of my investing career because I knew that from that day when I was 18

years old I knew that I had to make a payment basically into my future self so

that my investment could grow over time and by having that loan it it created a

pattern which I still follow today so something that I did when I was 18 I’m

now doing one in 39 so 21 years I’ve been contributing to this investment

plan and that’s why I’m able to be able to be retired later this year so let

what I want to do today is I want to do some fictional character analysis and

we’re going to compare two people that are both eighteen years old they both

work minimum wage kind of part-time during the school year and then

full-time during the summer months and so they have an average income of

$15,000 per year their current investment value is $0 and we’re the

reason that I’m using the small figures because I’m going to look at the

marginal tax rate for these characters both of them are their friends and they

decide that they’re going to that in 2019 is the year that they need to start

investing and they both want to contribute 16.7 percent of their income

so 16.7 percent of their income works out to $2,500 and they and that seems

like a reasonable goal so both of them make an agreement to each other they say

okay next month in March we’re gonna start – each of us are going to take

$250 put it into our RSP and at the end of the year ten months from now we will

have contributed $2,500 each first we’ll look at Bob scenario RSP contribution

for Bob is really really simple he’s gonna go to the bank he’s gonna open up

an RSP account he’s going to set up an automatic contribution of $250 so in

march march 1st to 5th new dollars beginning is gonna get transferred from

his savings account to his RSP account and then that money is going to start

theoretically growing at we’re gonna say a 7 percent rate of return because I

shown many times how easy it is to get a 7%

rate of return if you’re interested in that there’s a video link right up here

you can click on that you can see how to make a 7% return very easy chart he puts

in 250 dollars it makes a little bit of money makes a dollar 46 in the first

month so his total value at the end of March is going to be 250 $1.46 in theory

now in April first he puts in 250 dollars so now at the end of April his

total value a little bit of interest and we’re basically at 504 dollars carry on

through the year at the end of the year he’s contributed $2,500 his investment

is worth twenty-five hundred and eighty one dollars so he’s made a total profit

of 8163 and this is average and theoretical so you know take that into

account when you’re looking at any of these spreadsheets now Alice what she’s

gonna do is she’s going to say you know I I can be smarter about this I can put

the whole twenty five hundred dollars in right now and I can get a larger refund

from my tax return that is deferred taxes that and then it can pay it later

in my life when I when I have more money so she does a quick search on the

internet and she comes up with an RSP loan calculator I’ll leave a link down

in the description below for the websites that I’m using today she wants

to borrow twenty five hundred that’s her goal twenty-five hundred dollars

is this a top up loan no this is brand new the loan repayment period we’re

gonna say one year because she wants to pay back within the same year that Bob

does the payment frequency she’s gonna make a monthly payment now the interest

rates this this is gonna vary depending on your situation but I’m gonna put in a

four point seven five percent interest rate and then do you want to defer the

start of your loan repayment by up to 90 days saying no because in this case

alice is going to start contributing next month in March anyway so she’s

gonna make her very first loan payment of $250 that’s how much she’s going to

invest the same is Bob on March 1st so we’re not gonna defer the payment and

then we’re gonna click continue so tax information once your marginal tax rate

now in order to figure that out there’s that here’s another website that I found

I’ve typed in the income 15,000 click to calculate a marginal tax rate for

British Columbia and living on 15 a year is around 20% it’s super easy

calculation there’s many websites out there to tell you what your marginal tax

rate is based on what your income is we’ll go back to the loan and we know

the marginal tax rate is 20 percent so we’ll type that in 20 percent and then

the percentage of tax refund to apply to the loan balance now this is the the

most important part about this type of strategy because you’re making this

investment in the RSP then you’re a refund from your income tax is going to

be greater so the worst thing that anyone could do is go on just spend tax

refund because they’ve borrowed money to to invest and then they’re getting more

money back from their refund if they spend it that money is just gone so what

needs to happen is they need to take that refund and apply it to this loan so

we’re gonna say a hundred percent of the the return that we’re getting is going

to go to back to the loan now we know that if the marginal tax rate is 20

percent when you best twenty five hundred dollars twenty percent of twenty

five hundred dollars is going to be five hundred dollars so our income tax refund

is going to be increased by five hundred dollars more than if we had made this

RSP contribution so that five hundred dollars is going to go back to the RSP

loan and you’ll see that in the chart when we fill this out so we’re gonna

click continue estimated annual rate of return RBC

wants to say SEC six percent I’m gonna put in seven percent here it doesn’t

really matter we’ll look at that even if it’s a zero percent we’ll look at how

the benefits or non benefits of this work out in the end so the number of

years to retirement now both these characters are 18 years old so we’re

gonna say they’re gonna retire at 65 so forty seven years and click continue you

have to remember this is from a $2,500 investment if you’re twenty five hundred

all investment in one year if you hold it for forty seven years at a seven

percent rate of return your RSP is gonna work worth sixty thousand dollars

twenty-five hundred becomes sixty thousand dollars this is the power of

compound interest the expected tax refund and twenty five hundred dollars

we knew that it was going to be five hundred because we can do that Mathis

twenty percent which is what the marginal tax rate is if your marginal

tax rate is lower then you’re gonna get less money back if your marginal tax

rate is higher you’ll get more money back so the amount of tax refund to

apply to the law five hundred dollars that’s the super important part the

payment that Alice has to make is actually only two hundred and $13.73 now

we said at the beginning of the video both of them are gonna invest $250 so

she sets up this automatic loan payment for two hundred and thirteen dollars now

the remaining thirty six dollars is gonna go into her ARS pieces she’s gonna

add that as a supplementary payment and I’ll fill that out look in the chart now

the total cost the total interest cost and this is important for everybody like

how much is it gonna cost me to borrow this twenty five hundred dollars for the

year and repay back the total interest cost is only fifty dollars it’s

relatively low and this is based on that four point seven five percent interest

rate that we put in so the adjusted loan amortization is ten months so basically

she’s gonna have it paid off by the end of ten months we’re gonna look at the

loan amortization table we’re gonna click on that and basically what that

shows us is that the loan balance is twenty five hundred the first payment of

two hundred thirteen dollars two hundred thirteen goes to principal zero goes to

interest and the loan balance is paid down then the the next month you still

make a payment of two thirteen the principles one ninety four and the

interest is eighteen ninety five so this eighteen ninety five is actually the

interest for both months I don’t know why it’s calculating out like that but

that’s what it’s doing third month two hundred and thirteen dollars the

principal two hundred and five eight dollars in interest this is in the

fourth month where Alice has taken her five hundred dollars extra and she’s

applied that as an extra payment to the law so to her payment instead of being

two hundred and thirteen dollars is actually seven hundred and thirteen

dollars so she still pays a little bit of interest but a huge amount goes to

the principle which we scroll down to the bottom and we can see that at month

ten or in December the the balance on the loan remaining is zero and she

hasn’t invested her $2,500 now let’s put this into a spreadsheet to show the

returns on investment so if we go back to our sheet I’ve copied and pasted the

information from the RBC website see the payments – thirteen – thirteen –

thirteen this larger one to five hundred dollars more seven thirteen right down

to the bottom and the the loan balance goes down we could see the calculation

how much interest is paid works out to the same what happens with the RSP

immediately when she gets the loan she she owes that money but she takes that

money she puts it in the RSP we’re RSP contribution of twenty five hundred now

the RSP values twenty five hundred as I said before they’re gonna she’s going

that’s $250 per month 213 plus 36 27 equals 250 so that her her contribution

per per month is the same as Bob’s $250 so the value is increasing a little bit

faster at the end of the year when we can look at all of these payments she’s

made a total payment of twenty five hundred dollars out of pocket over the

course of the year of course this doesn’t include the five hundred dollar

refund that she got because that was money that she wouldn’t have gotten had

she not put in the money into the RSP the RSP value is it three thousand one

hundred and eleven dollars and she is put in twenty five hundredths so she is

effectively made six hundred and eleven dollars compared to Bob’s eighty one

dollars there’s one other factor that we have to consider and that’s the $2,500

that Bob put in during 2019 in 2020 in his return he’s actually going to get

the same $500 back that Alice received in extra refund and this is kind of a

residual thing I’m actually gonna make a separate video on this well put the link

up above when I’ve got that in there and you guys can check out that video

because it’s gonna show the breakdown the trickle-down effect of the marginal

tax rate and the RSP refund that you get from that anyways I’m gonna show you the

quick numbers we’re just gonna go through it basically what happens is

each year subsequently if they keep reinvesting that refund they just

continue to get a little bit more of an extra refund looking at after five years

of residual income twenty-five hundred dollars invested by Alice is worth four

thousand five hundred nineteen dollars the twenty five hundred dollars invested

by Bob is worth four thousand four hundred eighty three dollars the

difference is less than forty dollars difference between the two if we change

this rate to zero percent even though the RSP value was greater at the

beginning in this lump sum she’s actually returned less at a zero percent

return so the big takeaway from this is you know but Alice is making a little

bit more money she’s paying definitely some interest she actually makes a

little bit more return because she’s invested sooner but if the mark

it is going down Bob’s getting the benefit of dollar cost averaging and I

think for the amount of work that Alice had to do applying for the loan making

sure the loan payments go through transferring extra money in with her RSP

each month and Bob just has a straight-up contribution I mean I would

personally would probably go with Bob’s approach just make that contribution

automatic and get rich over the long-term anyways I hope you guys

enjoyed this video remember to hit the like button down below subscribe if you

haven’t turned on your notifications bell and let’s get rich together

Let me know what topic to cover next!

Thank for the video. Very well done as usual. There is another situation where borrowing can be profitable. Let say you already contributed $10 000 to your RRSP an marginal tax rate is 35%. How much can you borrow so the amount you borrow equal to the total tax return of the $10 000 + the borrowing? Lets do the math.

x is the ammount we are borrowing. The equation look like that: x= (10 000+x)X35%. The solution is x=3 500/.65 or x=5 384.

The total contribution would be $15 384. The tax return of $5 384 would be received 4 months after the borrowing and only a smaller interest has to be paid. (I guess $70)

The extra $5 000 dollars would generate income immediately. If we do not do that and wait the $ 3500 tax return and invest it in June we are losing 4 months of income and for the rest of the year, we have less money to generate income. If invested in a RRSP this amount would generate a tax return of $1225 in June of the following year. And that $1225 return, if invested in RRSP would generate a tax return of $428 2 years after the initial re investement. Lets do that again and at year 3 we have another $150 to invest and then we reach almost the same amount of inversting we have in the borrowing scenario.

You better than me to put that in a Excel sheet. I hope you can plot that with the interest return etc. My guess is that it can be a profitable use of borrowing.

I'd love an updated video on your stance on cryptocurrencies going into 2019

not deleting comment because it was posted, but my information was wrong. Thanks to Bob Lau for pointing itMarginal tax rate is important for tax refund for sure on the RRSP itself, but it is also important on the loan itself because the interest is a write off.

Say one has a portion of his income in the 40% rate and they gets say 4% interest on the loan after the write off they really only pay 2.4% interest. Will adjust my comment if your video covers this. Just didnt want to forget to mention it because you are usually extremely thorough.

Does being self employed change anything with regards to investment strategy? What about being incorporated vs not?

Interesting. Could you also make a topic for us European viewers? Understandably you post a lot about the Canadian and Us market and ways to invest but for example, you talked once about Robinhood, an easy way (almost) no fee way to invest in stocks. Nevertheless, one can't use this way because not possible if you are resident in Europe. There are some that we could use but some of them apps are restricted to the UK, so no solution either there, would there be a thrustworthy investment app, usable for all European residents, no matter the country there?

Solid video, thanks!