STRATEGY SHEET

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.