Bad RRSP Catch-up Loan, BAD
Posted by Gail | Filed under Debt Traps, Gail Club News, Retirement Planning
Gail Club News: They say sometimes a good idea has to simmer. This week I’ve received a flurry of emails from people who want to start a Gail Club. Join Lynda in the Windsor/Essex County area, Jessie in Calgary, and Derek in Toronto in establishing Gail Clubs. If you are interested in joining these folks, or starting a Gail Club of your own, email me at getgvo@gmail.com and I’ll try to match you up with people in your area.
I received this letter recently and I want to use it as an example of why you need to do the math before you take advice, particularly from someone who has something to gain from your decision. Marlaina wrote:
I am a huge fan and thought my husband and I were doing so well until I took a look at reality. My husband and I are 30 and 27. We have 3 children all under the age of 5 and it seemed that we were doing really well considering we have a nice house, and 2 vehicles that are both paid off. Last year we converted our mortgage into a LOC in order to reduce our payments and get further ahead then our financial advisor suggested RRSP loans to help us start saving for our future, now we have 2 RRSP loans one for 35000.00 added to our LOC at an interest rate of 3.5% and a 20000.00 loan at 8.5%. It helped us as far as my Child tax b/c now I bring in 766.00 as opposed to 180.00 but our total debt adds up to 278,000.00 including our house. I make sure to pay as much as I can every month on to our LOC but I still feel sick. Our min. payment on our LOC is 825.00 and I try as much as possible to put at least 1200.00 and any other money we come into on it as well. I have no choice but to stay at home with our kids as getting a job would make no sense considering my commute and child care would bring nothing to the table. My husband has been trying to find extra carpentry jobs but with the economy he isn’t finding a lot. Should I be freaking out? There is no way that we can pay all of this debt in 3 years…What do we do? Should we try to roll it into a mortgage. Are we doing really bad, I feel like such a failure. We have been implementing your jars but still can’t seem to get ahead and my husband and I really aren’t big shoppers. PLEASE HELP!!
Okay, can anyone spot the first mistake Marlaina and her husband made? Why would anyone convert a mortgage to a line of credit? If you want to make extra payments and get the debt paid off faster, you always have the option of increasing your mortgage payments or making principal prepayments. So the conversion to the Line is only good for one thing: to give you access to your equity more easily so you can use that money for other purposes.
Which is exactly how the “advisor” then positioned the RRSP catch-up loan as a GREAT idea, and so easy to do.
With RRSP season just around the corner, the ads for catch-up loans have already started on TV. Lenders who want you to think you’re richer than you are have been using the catch-up RRSP loan as a way to pin people’s wings to the table for years. I’ve written about it before. But this letter from Marlaina really brings the point home.
With RRSP catch-up loans amounting to $55,000, what hope in hell do Marlaina and her husband have of managing their cash flow to meet their family’s ongoing needs WHILE continuing to save for emergencies and for the long term. The plan has become unbalanced, weighted too heavily in debt, all for the sake of what? Long-term RRSP growth? A fatter child tax benefit?
This poor woman is sick with worry and feels like the rug has been pulled out from under her. She was taken in by a very bad idea. And I want you all to pay attention to what I have to say next.
Borrowing to contribute to an RRSP only makes sense if you’re in the highest tax bracket AND you can pay off the loan within one year WHILE making monthly contributions to your current year’s RRSP.
All three things have to be there. Otherwise, borrowing to contribute to an RRSP is NOT A GOOD IDEA! I don’t care how many ads you see, how many intriguing calculations you are shown, how many dollars back in tax refund you’re promised.
As for Marlaina and her husband, it’s going to take a lot longer than three years to get that RRSP catch-up loan debt repaid… perhaps as long as ten years… and all the while the lender will be raking in the profit in terms of the interest on that catch-up loan.
What would I do if it were my dilemma?
First, I’d go find another institution to deal with, one that values my financial health a little more, and is willing to help me achieve MY goals.
Then I would roll all the debt into a mortgage and get those payments in line with my cash flow so I could sleep at night. My budget would include money for on-going emergency and RRSP savings.
Finally, I’d find a way to make some extra money to build up annual prepayments against the mortgage to offset the interest on those old catch-up loans. It may take until the kids are in school full time before there’ll be enough time to make this a reality, but with some focused effort, a $278,000 mortgage can be whittled away by steady annual prepayments.
The biggest thing is to get the whole plan back into balance. Saving for the long term isn’t magic, it’s discipline and it takes time. Taking on too much debt for the sake of some other objective is a sure way to mess up your cash flow and rob you of sleep.
Slow and steady wins the race.
January 22, 2009 at 8:10 am
Marlaina may not be able to go back to work but what about doing something like child care for other parents in her community? A home daycare would be simple for her to set up since she already has children in that age bracket. She could take in 2 children (you’re only allowed 5 under 5) to bring in some income to boost her family financial situation.
January 22, 2009 at 8:52 am
Diana is Right. Marlaina, if you set up some sort of home business, not only you will be able to bring in some money into the household, but also you will be able to deduct some of your home expenses, as you might be using for example a home-office, or the basement for a daycare centre. You have to check your local laws and find out how many kids you will be able to have (plus your own). With a little bit of research, even if you bring in 100 extra a week, it will help to reduce your mortgage by about 5,000 per year (just with this extra money). Another suggestion is to have your mortgage paid accelerated. Most banks allows you to swtich from Monthly to weekly accelerated. Just that changed on my mortgaged brought it from 25 years to about 18. You can also ask them to increase the payment of about 10%, which if you do it weekly it’s almost nothing (depending on your payment), and that extra 10% goes towards the principal, reducing overall your interest.
I really thought that RRSP loans were good until today. I had a RRSP Loan about 5 years ago, which was paid in less than 6 months, but I really didn’t like to have to pay a loan. Now, bi-weekly contributions seam to be a better solution for myself and my family.
January 22, 2009 at 9:16 am
The financial institution’s name should be provided. The fact these places play this way is underhanded and need to be punished in one way or another. It’s rather unfortunate that the government of Canada and these businesses are such good bedmates because there is currently no accountability and no control (other than merger prevention, which at this point they might as well as combine into one being that it would seem they’re all in collusion with each other). Well, that was my quick morning release rant.
January 22, 2009 at 9:29 am
Has this couple made an official complaint against their Financial Adviser? I would be curious to see the file he/she has for this couple and the documentation he/she has to support this recommendation.
If the recommendation doesn’t agree with the “Know your Customer” form that the client filled out, than this could be malpractice.
If the FA is accredited (CFP, PFP, FCSI etc.) I would consider also complaining to the regulatory body.
Even if you are determined to borrow to invest (against Gail’s advice) it is technically a conflict of interest to get the loan from the same person who will be advising you on your investments. Banks get around this by putting a clause in the loan documentation.
This situation makes me MAD!!!!! It sounds like someone wanted to make their RRSP quota more than they wanted to further the goals of their client!
January 22, 2009 at 9:49 am
Question for those folks smarter than me about money – what’s the difference between making the payments on an RRSP loan or making monthly contributions to an RRSP?
Say myself – I am in the highest tax bracket and was contemplating taking out a $10,000 RSP loan in hopes of offsetting some of the income tax I am going to have to pay for last year (I was a self-employed consultant for part of the year).
So for instance if I was paying $400 a month for that loan and paid it off in 2-3 years, what would be the difference if I put $400 a month into an RRSP? Of course there would be a tax benefit to me every month, so that’s one benefit, but I need someone to tell me what huge difference would be between the two. If I got the loan now I would start making interest now on the $10,000, instead of $400 this month, $800 next month, etc.
Fortunately my employer gives me an extra 9% a month to contribute to a group RRSP, and I don’t have to contribute any of my own money to that 9%, so I am putting away almost 10% every month already.
January 22, 2009 at 9:59 am
@Karen – while you’d be earning interest now, instead of later, you’d also be paying interest on the loan starting now, instead of never. So you’d have to do the math – are you earning more in interest than you’d be paying? (doubtful in today’s circumstances.)
The way I see it, the objective of your RRSPs in this bad market is to simply preserve your capital. With that in mind, why spend 3.5% interest to borrow when you probably will not possibly be earning that much in interest growth. You’d need a mighty big tax gain to offset that ongoing loss.
You also need to consider how this affects your budget. Can you afford to make those payments? If your budget isn’t prepared to make room for those loans, you may find yourself resorting to other methods of borrowing, or falling behind, which will cost you more than you bargain for.
January 22, 2009 at 10:03 am
That’s a great question, Karen! I would love to hear the answer as well. Also, my (our) rrsp’s are in mutual funds in a higher risk – meaning we lost oodles of money – I won’t even look at my statement. Is this really a good idea? We were advised that we were safe to do this as we are fairly young, and any drops would eventually work out…as for getting a loan – no matter what it’s for – I don’t want to owe anybody any more money than I already do, and once it’s cleared, I still don’t think I’d do it. At least with monthly payments, I can choose not to put in that month (or several-like now) if something goes wrong financially. With a loan you’re stuck with that payment no matter what! That’s how I look at it, anyway!
January 22, 2009 at 10:05 am
@Karen, I”m sure as a consultant you’re aware of all this, but don’t forget to offset your net income with all expenses, including the portion of your mortgage/rent (the office space as a percent of your square footage) a portion of your utilities (using the same formula) any furniture or equipment you bought, mileage for travel to business meetings with clients, cost of internet, cost of phone calls and cell phone bills, etc.
Also, remember that your consultant hours do not necessarily add to your RRSP contribution limit.
January 22, 2009 at 10:41 am
Thanks Saver Queen and Michelle – I am really now considering not borrowing for the RRSP and just paying the tax. Fortunately I only consulted for a few months last year, but it’s still almost $65,000 in income . While I do have expenses they won’t offset it enough and I’ll still have to pay a ton of income tax, and fortunately I have most of that money saved.
And considering the almost six-figure loss I took on my RRSP’s in the past few months, I am wary of putting a large amount of money into more RRSP’s anyway. I wish I had put most of that money into paying off my house, as the house is now worth 3 times what we paid for it 12 years ago. It would have been the better investment….ah, hindsight! All the interest I made in that time on my RRSP’s is gone, plus some of my own hard-earned cash and I probably won’t make most of it back before I retire.
January 22, 2009 at 10:54 am
Karen:
I agree with Gail about RRSP loans. If you take a loan for $10000, you might get $3500 back in the spring which can be used to repay part of the $10000. That leaves you with $6500 to repay on the loan. Can that $ be repayed within 6 months? After the 6 months, put the equivalent amount directly into RRSP payments for 2009 and don’t forget to fill out your t1213-04 (see one of Gail’s previous post about bad tax return). You have to be good!
Gail:
I am assuming that the t1213-04 is ONLY good for RRSP contributions and NOT loan repayments. If I am correct, that is another advantage.
January 22, 2009 at 4:46 pm
We got burned by our FA and we won’t go back. There’s so much conflict of interest in the field. Plus, it didn’t take us long to figure out that she gets paid even if we lose money, so it’s not like she had any real stake in our success.
At the moment I see an even bigger problem with borrowing to invest. I know people who have been margin called, because they had big loans and the asset dropped 50% or more in the recent economic downturn. Then you`re really in trouble.
January 22, 2009 at 11:25 pm
I don’t see a lot of benefit to RRSP Catch Up Loans in the current economy either. I can see the reasoning if one is in the highest tax bracket, but for most of us we will pay more interest than we will earn, so what’s the point?
I think Registered GICs are a faily good option right now. Rates still are not great (3-5%) but atleast your not going to lose your money. You can choose a 3-5 yr term, and hopefully the economy will see some improvement by the time the investment matures.
I think Gail’s advice to Marlaina is wonderful (as usual). Refinance that baby! A fixed pymt makes a huge difference when you have 3 little ones to consider and are trying to make ends meet.
Gail, why would the RRSP contribution create a higher CTC?? Or am I not understanding something?
January 23, 2009 at 6:46 am
Melaniesd, when you claim an RRSP deduction, you lower your taxable income. You may in fact lower it to a new bracket, in which case you’d qualify for more CTC. g
Marie, yes you are right.
Karen & Michelle, Saver Queen is correct. I recommend exactly what you suggest Karen. Figure out how much you would pay on the loan and instead of borrowing and making loan payments, make that amount your monthly RRSP contribution.
January 23, 2009 at 7:45 am
The question I have (unless I missed it) is what did they do with their tax refund? Since you can’t write off the the interest, a RRSP loan should be paid off with in a year when you use the tax refund (ususally six months). The best is to avoid RRSPs loans in general, but there is a few cases where this makes sense.
The markets can through long periods of little or no return! There is lots of examples of this. Dow Jones 1929 to 1954 zero! After the bear market in the US of 1973 to 1974 (the Dow Jones lost about 50%) the market returned to 1966 levels! Treat RRSPs like a pension that must be there in the future. With GICs at a historic levels you must save much more to meet retirement goals, at 4% it will take 20 years to double your money. There is no easy answers!
In this market believe it or not, the real risk is not the market or housing prices ( the next shoe to drop) it is the job market. The key is to ask your self if I lost my job today, how long will it be to get a new job at about the same pay and benefits? With interest rates at all time lows, poor savings rates, high debts, and two wars, the unemployment picture will get much worse before it gets better. The government can only do so much spending and cutting interest rates…after that this economy will have to find a bottom and rebuild. The problem is many people think it will be a short time, but it could last for years.
regards,
Brian
January 23, 2009 at 9:54 pm
This may be a silly question….
My husband and I are both self employed.
How do I know what “Tax Bracket” we are in?
How many tax brackets are there?
I need to learn some more about this…. google time…
January 23, 2009 at 11:43 pm
Jasmyn:
Your Revenue Canada package, schedule 1 (step 2) and equivalent ‘form’ for your province.
For Canada, in 2008:
If you earned (according to ‘line 27/line 260′) between $37885 and $75769 (this is the bracket range), your federal marginal tax rate would be 22%. Do the same for your province (the brackets vary by province and so do the percentages) and add the two percentages. If your province taxes you at 10%, your marginal taxe rate is 32%. Any extra dollar you make is taxed at 32% (on average you pay less).
Next federal bracket: $75769 to $123184. This is taxed at 26% by the federal.
So people want a big income with a low value on ‘line 27/line 260′. One way to do this is pension contributions (if eligible).
January 27, 2009 at 12:47 pm
I was wondering if anyone has some options for me about RRSPs.
Currently I work in the public service so I have a pension but I might not for my entire life.
I’m 26 years old. I gross over 80,000/yr so I’m in a high tax bracket.
Should I be contributing to an RRSP and get the tax breaks or does it not make since because of my current pension plan?
I just started a TFSA.
January 28, 2009 at 2:00 pm
What is your view on borrowing to invest if you can spare the money for the loan?
The reason I ask, is so many people say the markets are down, and now is the time to buy. I am a government employee (stable income), and I have religiously bought RRSP’s every month for the last 5 years, with some room left to buy more RRSP’s.
Since I am in a fair tax bracket, with a good return for income tax to invest in a RSP shelter, with current low interest rates, I am good with savings (40% increased mortgage payments, kids schooling, rainy day fund), I can free up a few hundred a month to buy some stocks or funds to invest.
Our only payments is our house, and a mini van we needed for another addition to the family (ever put a couple baby seats in the back of a VW?) at 0% (I know still credit). All other debt will be gone in 3-4 months, all thanks to your jars!
“Historically” I hear this would fit the “buy low” timeframe to “sell high” in the future.
What would be your input for those who can spare a little to invest? Buckle down and save it away or pay house off faster, or borrow while interest rates and stocks/funds are down and roll the dice the stocks/funds will recover in the future?
Or am I just a sucker to all the sales pitches as well to borrow to invest?
February 7, 2009 at 12:34 pm
Brian, while you are correct based on the theory of these loans, what I always find infuriating about the RRSP catch up commercials is that not everyone will receive a tax refund as a result of the RRSP contribution. While at the end of the day, the figures may be the same, people are so under-educated in all matters financial that they naively trust what the advisor tells them. So the advisor tells them to borrow the money and then they show the person that at x tax bracket, you will get y dollars back. However, they don’t do the real calculations so there may not be a refund to pay back to the loan so the entire calculation by the advisor is flawed.
February 7, 2009 at 12:39 pm
For those of you calling for disciplinary action for the advisor, I don’t see that the person did anything illegal or unethical. Was the advice bad? Probably. But there is also a responsibility of the individual to weigh the advice against their own situation. I am against bank advisors in general because they can only recommend their own products and as someone mentioned, they get money on both fronts, the fees from the RRSP and the interest from the loan. And the advisor is on salary so they have no stake in the success of the plan. You may want to contact a fee for service planner where you pay them by the hour. Moneysense magazine has an article about this in the current issue and they have a list of fee based planners on their website.
February 7, 2009 at 12:49 pm
Jasmyn, go to http://www.ey.com/GLOBAL/content.nsf/Canada/Tax_-_Calculators_-_2008_Personal_Tax which is Ernst and Young tax calculator. You can plug in your income and see what your tax liability is and also what your bracket is. But remember you also have to add in 2 x the CPP contribution to the amount owing. For 2008, the maximum was $2049 so at the maximum your additional amount would be $4050 (for each of you!). And on that site it gives you 2 figures ~ your average rate and your marginal rate. The average is simply your total tax divided by your total income. The marginal rate is a bit more confusing. Technically it is the tax you pay on the NEXT dollar you make. So if you are in the 31% tax bracket, and you add on another $1000 of income (maybe as an RRSP withdrawal or as a part-time job) you will pay $310 of tax on that income. On the flipside, if you reduce your income (RRSP contribution is the most common example) you would get 31% of the contribution as a tax reduction.
Susan
February 8, 2009 at 12:03 am
Karen, as a consultant, you should change your GST method to the quick method. As a consultant you will have few expenses and the quick method will work out in your favour. Get more information here. If you like, I can send you a simple excel sheet I set up to do the calculation.
http://www.cra-arc.gc.ca/E/pub/gp/rc4058/rc4058-e.html
August 13, 2010 at 6:34 pm
how do you come up with 42,000 in interest cost at prime?