The Gross-up RRSP loan allows you to make a larger RRSP contribution than you otherwise would have. I know it sounds a bit strange to borrow and save at the same time but the strategy can ultimately improve your financial position. Over the long term, the benefits of deferring taxes and earning compound interest can far outweigh the interest cost of using a loan to contribute to your RRSP. The strategy is basically borrowing the exact amount needed for the RRSP refund to completely pay off the loan immediately (a few weeks later when your refund comes back after filing your tax return).
- You are in a 40% tax bracket and you have $6,000 available to contribute into your RRSP by the deadline date of March 3, 2014.
- You top up your contributions with a $4,000 loan and put a total of $10,000 into your RRSP
- A few weeks later you get your tax refund of $4,000 and you use it to pay back the loan
- The $10,000 starts compounding in your RRSP right away, and you won’t be tempted to blow the refund on things you don’t really need
Below is the calculation to determine how much to borrow to generate a refund close to the amount of the RRSP loan:
(RRSP Contribution available x Marginal Tax Rate) ÷ (1 – Marginal Tax Rate) = RRSP Loan
Our example ($6,000 x 40%) ÷ (1 – 40%) = $4,000 RRSP Loan
Doing this calculation will give you an idea of how much you should borrow to ensure that the amount of your refund is close to the amount owed on your RRSP loan. There will likely be some interest due when you pay off the loan which is not accounted for in the gross-up calculation. If you repay the full amount of the loan quickly, however, the amount of accrued interest should be minimal.
Your Marginal Tax Rate (MTR) is the amount of tax you pay on the last dollar earned. Ask your Financial Planner for help figuring out what your MTR.
Rules for successful implementation of the Gross-up RRSP loan strategy:
- A portion of the RRSP contribution must come from your own savings.
- The expected tax refund should be the same as the amount borrowed (not including interest).
- The tax refund must be used immediately to pay off the RRSP loan.
- There must not be any outstanding personal tax liabilities.*
- Home Buyer’s Plan or Life-Long Learning Plan repayments must be considered separately from the strategy, as they will not generate a tax refund.
The gross-up RRSP loan strategy should only be implemented after consulting with your Financial Planner. Everyone’s situation is unique, and there are many things to consider when making RRSP contributions and borrowing money.