With the busy rrsp season quickly approaching, and interest rates creeping up slightly, now is an ideal time for advisors to wrap their heads around catch-up and top-up loans — the easy money financial institutions make available to encourage Canadians to contribute to their registered retirement plans.

These investment tools are popular with investors. According to Toronto-based research firm Investor Economics Inc. , Canadian banks and their trust subsidiaries had almost $2 billion in outstanding RRSP loans at the end of the second quarter. And as banks head into the first quarter of 2006, that should rise to more than $2.3 billion. And that doesn’t include borrowing figures from mutual fund trust companies such as AGF Trust Co. , which has $200 million in loans, MRS Trust Co. , which has $50 million, or insurance company loan programs.

But even though Canadians appear willing to tap the debt market to fund their RRSPs, there’s a whole lot more borrowing they could be doing. According to Statistics Canada, by the end of the 2004 taxation year, there were 18 million Canadians who had accumulated $377 billion in unused contribution room since 1991. So chances are many clients are candidates for RRSP loans. But why should clients consider this type of loan?

“RRSP loans are a great vehicle. They are a really cheap form of financing,” says Stephen Wiles, an advisor at Edward Jones in Dartmouth, N.S., who touts such loans regularly to clients. He adds that an RRSP loan is a wonderful tool for small-business owners because it allows them to keep their credit lines for business emergencies.

Another benefit of RRSP loans is their availability. The major chartered banks offer them, as do key financial institutions that serve advisors, including AGF Trust, MRS Trust and Laurentian Bank of Canada’s B2B Trust.

Generally, all offer three types of RRSP loans, but the characteristics differ slightly and the rates can vary significantly:

> The short-term loan is usually for a period of less than two years. Designed for those who want to put it toward an annual contribution, they are typically a few thousand dollars.

> Mid-term loans are usually in the three- to five-year range and are directed toward investors who want to maximize their annual contribution room. They are often for more
than $10,000.

> Long-term loans are for serious investors who want to take a bite out of their unused contribution room. These can run into the tens of thousands of dollars.

Depending on where advisors and their clients shop, they can find some good deals.
RRSP loans are very flexible and there is often no limit on the maximum amount that can be borrowed. They also have open-ended, prepayment options, which allow them to be retired quickly.

Rates also vary considerably. John Bennett, executive vice president of AGF Trust in Toronto, says his firm offers loans with interest as low as prime minus one percentage point to a couple of percentage points above prime. And the firm guarantees that your clients will be entitled to some form of loan, although it may not be exactly what they had hoped for.

Interest rates on MRS’s loans range between prime and prime plus two percentage points, says Paul Stadnik, assistant vice president of retail credit products at Mackenzie Financial Corp. in Toronto. He also notes that a typical loan is in the $6,400 range, up from the $5,400 level of a few years ago.

Wiles recommends these loans be pitched to clients any time clients can afford them “because it gets clients in the market.” And the earlier they invest, the faster that money can grow, says Vas Pachapurkar, regional director at Investors Group Inc. in Toronto.
Say a client has $5,000 and borrows $5,000 for a $10,000 contribution. Based on an 8% return, that $10,000 will grow to more than $100,000 in 30 years. The cost of the loan, if paid off in the first year, is less than $250. “You have that extra $5,000 compounding and working,” he says.

“It increases a client’s return on investment,” adds Patricia Lovett-Reid, senior vice president of TD Waterhouse Canada Inc. in Toronto, noting the compounding effect helps “a 10% return become a 12.2% return after five years.” For example, she says, an initial investment of $1,000 at 10% interest becomes $1,100 after Year 1, $1,210 in Year 2, $1,331 in Year 3, $1,464 in Year 4 and $1,611 after five years, for a return of 12.2% in the final year.

@page_break@Another strategy worth considering applies to clients whose earnings put them close to a change in tax brackets. For example, clients earning $36,000 in Ontario could borrow $6,000 for an RRSP contribution, which would reduce their income to $30,000. That would bump them down to the lowest income tax bracket for both the federal and provincial government rates. A one-year, $5,000 loan at 4.75% interest would cost less than $285 to service, but could save the client a few thousand dollars in taxes.

Baby boomers

Other candidates for RRSP loans are the many baby boomers who are nearing their retirement years and have not maximized their RRSP contributions, says Lovett-Reid:
“RRSP loans are a good way to do that, particularly before interest rates start accelerating.”

It’s not too late for clients in their late 50s or early 60s with contribution room to borrow, if they can afford the loan payments, she adds. That is because they won’t have to withdraw money until they are 69; and, at that point, they can roll their RRSPs into RRIFs, keeping them sheltered from taxes.

“If you have unused contribution room in your 60s, it can be advantageous to catch up, provided you are in an upper marginal tax bracket. You’ll get the biggest bang for your tax dollar,” Stadnik adds.

With your younger clients, an RRSP loan will not only introduce them to the concept of saving for retirement early in life, but it can also help them develop investment discipline and a credit history. And by contributing regularly early in their lives, they will reduce the possibility of carrying a large amount of unused contribution room as they age.

Although some advisors shun credit, AGF Trust’s Bennett says the question isn’t about whether a client should have an RRSP loan. Rather, he says, “It’s how to borrow most effectively.” Most people have debt of some kind, he notes, and if an RRSP loan can generate a tax refund that is used to pay down higher credit-card debt, for example, the client is further ahead.

The danger inherent in RRSP loans, as with any other loans, comes if clients are too financially stretched to make the payments or take too long to pay the loans back. But many people use the tax refund that the contribution generates to pay down the loan and thus pay it off faster, he says. IE