December 1999

“Catch-Up” RRSP Strategy
Makes Sense in Most Cases

© Talbot Stevens

Does it make sense to borrow to “catch-up” on your unused RRSP contribution room that just seems to get bigger every year?

Many advisors recommend avoiding big RRSP loans. However, my research shows that the catch-up RRSP strategy generally produces a larger retirement fund, even when investment returns are lower than the interest rate on the loan.

Recall from earlier Strategy Sheets that there are at least 5 RRSP refund strategies, and that choosing the right one can increase your retirement fund by 30 to 50% or more. Let's compare the catch-up strategy to the other approaches where no loan is used.

Say that Sue is well into the 40% tax bracket and has $20,000 of unused RRSP contribution room available. If she gets a $20,000 RRSP catch-up loan, she will get an $8,000 refund which can immediately reduce the loan to $12,000. With an 8% non-deductible interest expense, the $12,000 can be paid off over 10 years with annual payments of $1,656.

Instead of paying off a loan, these annual payments could be invested into an RRSP each year, with the refunds being spent, reinvested, or grossed-up. The table summarizes the RRSP value for each strategy after 10 years.

In a 40% tax bracket, reinvesting all of the RRSP refund increases the amount contributed by 40% to $2,318 per year, and thus your retirement fund by the same 40%. Grossing up is even better.

Note that when investment returns match or exceed the interest rate on the loan, the catch-up strategy is always as good as or better than not using a big RRSP loan.

RRSP Value After 10 Years
RRSP Refund Strategy 6% Returns 8% Returns 10% Returns
Spend: $1,656/yr 23,140 25,910 29,030
Reinvest: $2,318/yr 32,390 36,270 40,640
Gross Up: $2,760/yr 38,560 43,180 48,380
Catch-up: $20,000, 8% loan 35,820 43,180 51,870

Even if returns are lower than the cost of borrowing, the catch-up loan is still generally better because it forces a higher level of commitment to the individual's retirement goal. Once started, the loan becomes a forced savings plan that generally results in more RRSP value than even if every penny of every refund was reinvested — and very few people do that.

With 6% returns, 2% lower than the 8% interest rate, the catch-up strategy produces $35,820 after 10 years, compared to $32,390 when all of the refunds are reinvested.

Each RRSP refund strategy equates to different levels of commitment, which is often the most important factor in financial success. The real benefit of the catch-up loan strategy is the forced higher level of commitment that produces a larger RRSP fund in almost all cases, even when returns are lower than the cost of borrowing.

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