Taking money from a line of credit to invest in an RRSP

Some people have recommended I take out a line of credit to contribute to my RRSP. How does this work? Is it a good idea to borrow money to invest?

The idea of making use of a line of credit in order to invest in your RRSP account is based on a couple of ideas.

For most of the past 20 years lines of credit have had low interest rates. This has made it relatively inexpensive to borrow money using a line of credit.
The stock market usually goes up, on average. As the value usually trends upward, investing earlier is usually good so you can buy at a lower cost.
When a person invests in their RRSP they get an income tax credit. This credit is usually for about a third of the amount invested. In other words, for every $3,000 you deposit in your RRSP account, you usually get a tax credit of about $1,000.

When these three ideas are combined, the general plan is to do the following:

Borrow money from a line of credit at a low interest rate early in the year, usually January or February.
File your tax return in March or April, which should give you a refund for a third of the line of credit. You then use this to immediately pay back part of the debt.
You gradually pay back the remainder of the loan over the rest of the year.
Meanwhile your new RRSP investments hopefully perform well, creating a return equal to (or higher) than the interest rate on the loan.

Over most of the past 20 years the stock market has generally performed well, averaging around a 7% return. Meanwhile lines of credit could often be acquired for an interest rate 6% or less. Which makes the plan mentioned above seem pretty solid. Let’s look at an example of how the plan plays out, assuming you borrow $15,000 from a line of credit to invest in RRSPs. Just for the sake of example, assume the line of credit has an interest rate of 6% and you make 7% off the investment. Here is how the numbers and process would look:

We borrow $15,000 at 6% in January and immediately invest it in an RRSP.
We get back a tax refund of $5,000 (a third of our investment). This money is put on the line of credit. Now we owe about $10,000 on the line of credit.
We pay down the line of credit at $1,000/month, plus some interest over the rest of the year.
Our RRSPs provide a return for the year of 7%.

In this scenario, we’ve basically paid $10,000, plus about $400 of interest, to invest $15,000 at 6%. At the end of the year we’ve used $10,400 of our money and our investment is worth $16,050. Which sounds like a good deal, right? It seems like an easy way to get a free $5,650 in your RRSP account.

Sometimes, in the right circumstances, this is a good idea and it can work. However, there are a number of potential problems or issues which prevent this approach from working out to your benefit. Here are some examples of issue or limitations which will prevent this strategy from working:

Your RRSP account has already reached its contribution limit for the year or is close to doing so. If there is no contribution room left, you can’t take out a loan to put more money into your RRSP.
If, for some reason, putting money into an RRSP will not result in you getting a cash tax return from the government. Maybe you already have enough credit to wipe out your income tax, your job doesn’t take off taxes, or you’re self-employed and haven’t paid in enough money yet this year. Basically, anything which prevents the government from sending you money for your RRSP tax deductions makes this approach much less appealing.
There is a possibility you won’t make enough money to pay back the loan. If your job might make less money this year, if you might be laid off, if you for any reason might not make enough to pay back a loan at a rate of (for example, $1,000/month) then borrowing money to invest is a bad idea.
If the line of credit interest rate goes up, as it did in 2022, then it suddenly becomes more expensive to borrow money. In the year 2000 it was fairly easy to get a line of credit at 6%. In the year 2022 you might be looking at a rate closer to 8% or higher. This isn’t necessarily a deal breaker, but you need to be able to budget for the possibility your interest payments will rise.
The stock market might be dropping. Through most of the past two decades the market has gone up. However, sometimes the market goes down. In the year 2021 you might have gained around 20% on your RRSP investment and been quite happy – your $15,000 RRSP deposit would have grown throughout the year to $18,000. In 2022 you probably would have lost at least 9% of your investment so your initial deposit of $15,000 would have finished the year at $13,650.
If you’re putting all your spare income into paying down your line of credit throughout the year then at the start of the next year you’ll find you haven’t put any money into your RRSP yet for this tax year. You may find yourself needing to borrow from a new line of credit to put anything into your RRSP for the next year, starting a cycle of borrowing to invest.

As you can see from the above list, there are a number of limits or potential problems with using the borrow-to-invest approach. It can work and, when borrowing rates are low and you have a lot of RRSP contribution room, it can pay off. However, there are risks, such as the possibility you might not be able to pay back the loan, the market could go down, or interest rates could rise.

Because of the potential issues, I would usually recommend that people not borrow to invest, or at least not make a habit of it. After all, a person who can afford to pay back a line of credit at $1,000/month also has the ability to invest that same $1,000/month into an RRSP without going into debt. It probably makes sense for most people to invest monthly as they have the money rather than perform a slightly risky move by borrowing money and paying it off later.

The people suggesting you take out a loan to invest in your RRSP account are right that it can be a useful trick to perform, sometimes. It can help you get ahead and may be of benefit, especially if you have a lot of RRSP contribution room and believe the stock market is climbing. But this approach has its limits and its risks. Investing money you’ve already saved in your bank account might offer a slightly lower benefit, but it also carries less risk and offers fewer complications.