With interest rates still near historical lows, does it make sense for an investor to borrow a larger amount to catch up on RRSPs when the loan might take 10 years to pay off?

Even though many experts discourage the use of long-term RRSP loans, most people would actually benefit from them, claims Talbot Stevens, a London-based financial educator, author, and industry consultant.

“If you just look at the math, RRSP catch-up loans always make sense when investment returns match or exceed the cost of borrowing,” explains Stevens. “If you can borrow at 6% interest and get returns of 6% or higher, you will come out ahead by borrowing to catch up on RRSPs, even if it takes 10 years or more to repay the remaining balance of the loan. If you average only 3% returns, you would be better not borrowing long-term.”

Stevens also likes the investment discipline afforded by long term RRSP loans. “When you also account for the behavioural reality that most investors spend their RRSP refunds, the scales tip heavily in favour of long-term RRSP loans, even when returns are half of the cost of borrowing,” says Stevens.

“For most investors, the catch-up RRSP strategy generally produces a larger retirement fund because the loan locks in a higher level of commitment. Once started, the loan becomes a forced savings plan, like a mortgage, where we don’t have a choice but to continue the payments.”

Stevens offers an example of two conservative investors, Bob and Anne, who expect to average modest 4% returns over 10 years. In a 35% tax bracket, they each have $1,730 a year to invest in RRSPs. Anne invests annually and if she is disciplined enough to reinvest 100% of her RRSP refunds back into her RRSP each year, she will have $29,160 after 10 years. Bob borrows and uses the same cashflow to pay off the remainder of a $20,000 RRSP loan charging an average of 7% interest over 10 years. Even though his 7% interest expense was almost twice the 4% returns, he ends up with $29,610, slightly more than Anne.

When deciding how much to catch up, Stevens suggests investors only borrow enough to make an RRSP contribution that reduces taxable income to the start of their current tax bracket. This will generally maximize tax savings.

Stevens notes that Canadians have over $377 billion of unused RRSP contribution room carried forward since 1991, averaging over $19,000 for each taxpayer eligible to contribute.

High unused contribution room combined with record-low personal savings rates of under 0% indicate that many Canadians are falling behind on their retirement savings, he concludes.