Welcome back to Drawbridge Finance. today we're talking about RRSP
loans. Hey Everyone welcome back my name is Levi woods. I'm not a professional
investor, I don't work in the financial industry and this is an opinion channel
about money. Today, I want to talk to about RSP loans and this is a
pretty touchy subject because basically the theory behind RRSP loans is that
you borrow money and then invest it.
Now you can invest in a guaranteed investments certificate and make a guaranteed return.
Usually that return is less than the amount of interest that you're paying on the
loan so it's a it's difficult to get those guaranteed investments to
pay more than the interest. It doesn't usually work out so what most people do
is they invest in the stock market or they invest in an ETF that's going to
potentially return an average rate of return that's greater than the amount
of the cost of the loan. If we could get a loan for four and a half or
four and three-quarters percent but we know that the S&P 500 returns around
seven point eight percent on average per year then in theory the the loan will
cost us less than the returning the investment now RRSP loans are interesting
RRSP Loans are available to Canadians and what they do is they allow the
borrower to borrow money to invest specifically into their RRSP before the
RRSP deadline of the end of February. What this does is it increases the amount
of refund that they get when they do their income tax. Now RRSPs are
not the best financial vehicle because we eventually have to pay that
tax in the future so it's something to take into consideration what the
marginal tax rate actually is and I'll cover that in this video but what what
it allows people to do is start investing without actually having any
money right now today for for myself I actually did this I have taken two RSP
loans in my life because when I was young I knew that I needed to start
investing they were not well kind because I was invested in the broad
market we know that we had the dot-com crash in the 2000s 1999
mm and I lost a substantial amount of that money that I had borrowed to invest
so I know firsthand that this is is a risky thing to do but what that did was
it set me on a path that I continued for the rest of my investing career because
I knew that from that day when I was 18 years old I knew that I had to make a
payment basically into my future self so that my investment could grow over time
and by having that loan it it created a pattern which I still follow today so
something that I did when I was 18 I'm now doing one in 39 so 21 years I've
been contributing to this investment plan and that's why I'm able to be able
to be retired later this year so let what I want to do today is I want to do
some fictional character analysis and we're going to compare two people that
are both eighteen years old they both work minimum wage kind of part-time
during the school year and then full-time during the summer months and
so they have an average income of $15,000 per year their current
investment value is $0 and we're the reason that I'm using the small figures
because I'm going to look at the marginal tax rate for these characters
both of them are their friends and they decide that they're going to that in
2019 is the year that they need to start investing and they both want to
contribute 16.7 percent of their income so 16.7 percent of their income works
out to $2,500 and they and that seems like a reasonable goal so both of them
make an agreement to each other they say okay next month in March we're gonna
start - each of us are going to take $250 put it into our RSP and at the end
of the year ten months from now we will have contributed $2,500 each first we'll
look at Bob scenario RSP contribution for Bob is really really simple he's
gonna go to the bank he's gonna open up an RSP account he's going to set up an
automatic contribution of $250 so in march march 1st to 5th new dollars
beginning is gonna get transferred from his savings account to his RSP account
and then that money is going to start theoretically growing at we're gonna say
a 7 percent rate of return because I shown
many times how easy it is to get a 7% rate of return if you're interested in
that there's a video link right up here you can click on that you can see how to
make a 7% return very easy chart he puts in 250 dollars it makes a little bit of
money makes a dollar 46 in the first month so his total value at the end of
March is going to be 250 $1.46 in theory now in April first he puts in 250
dollars so now at the end of April his total value a little bit of interest and
we're basically at 504 dollars carry on through the year at the end of the year
he's contributed $2,500 his investment is worth twenty-five hundred and eighty
one dollars so he's made a total profit of 8163 and this is average and
theoretical so you know take that into account when you're looking at any of
these spreadsheets now Alice what she's gonna do is she's going to say you know
I I can be smarter about this I can put the whole twenty five hundred dollars in
right now and I can get a larger refund from my tax return that is deferred
taxes that and then it can pay it later in my life when I when I have more money
so she does a quick search on the internet and she comes up with an RSP
loan calculator I'll leave a link down in the description below for the
websites that I'm using today she wants to borrow twenty five hundred that's her
goal twenty-five hundred dollars is this a top up loan no this is brand
new the loan repayment period we're gonna say one year because she wants to
pay back within the same year that Bob does the payment frequency she's gonna
make a monthly payment now the interest rates this this is gonna vary depending
on your situation but I'm gonna put in a four point seven five percent interest
rate and then do you want to defer the start of your loan repayment by up to 90
days saying no because in this case alice is going to start contributing
next month in March anyway so she's gonna make her very first loan payment
of $250 that's how much she's going to invest the same is Bob on March 1st so
we're not gonna defer the payment and then we're gonna click continue so tax
information once your marginal tax rate now in order to figure that out there's
that here's another website that I found I've typed in the income 15,000 click to
calculate a marginal tax rate for British Columbia and living on 15
a year is around 20% it's super easy calculation there's many websites out
there to tell you what your marginal tax rate is based on what your income is
we'll go back to the loan and we know the marginal tax rate is 20 percent so
we'll type that in 20 percent and then the percentage of tax refund to apply to
the loan balance now this is the the most important part about this type of
strategy because you're making this investment in the RSP then you're a
refund from your income tax is going to be greater so the worst thing that
anyone could do is go on just spend tax refund because they've borrowed money to
to invest and then they're getting more money back from their refund if they
spend it that money is just gone so what needs to happen is they need to take
that refund and apply it to this loan so we're gonna say a hundred percent of the
the return that we're getting is going to go to back to the loan now we know
that if the marginal tax rate is 20 percent when you best twenty five
hundred dollars twenty percent of twenty five hundred dollars is going to be five
hundred dollars so our income tax refund is going to be increased by five hundred
dollars more than if we had made this RSP contribution so that five hundred
dollars is going to go back to the RSP loan and you'll see that in the chart
when we fill this out so we're gonna click continue
estimated annual rate of return RBC wants to say SEC six percent I'm gonna
put in seven percent here it doesn't really matter we'll look at that even if
it's a zero percent we'll look at how the benefits or non benefits of this
work out in the end so the number of years to retirement now both these
characters are 18 years old so we're gonna say they're gonna retire at 65 so
forty seven years and click continue you have to remember this is from a $2,500
investment if you're twenty five hundred all investment in one year if you hold
it for forty seven years at a seven percent rate of return your RSP is gonna
work worth sixty thousand dollars twenty-five hundred becomes sixty
thousand dollars this is the power of compound interest the expected tax
refund and twenty five hundred dollars we knew that it was going to be five
hundred because we can do that Mathis twenty percent which is what the
marginal tax rate is if your marginal tax rate is lower then you're gonna get
less money back if your marginal tax rate is higher you'll get more money
back so the amount of tax refund to apply to the law five hundred dollars
that's the super important part the payment that Alice has to make is
actually only two hundred and $13.73 now we said at the beginning of the video
both of them are gonna invest $250 so she sets up this automatic loan payment
for two hundred and thirteen dollars now the remaining thirty six dollars is
gonna go into her ARS pieces she's gonna add that as a supplementary payment and
I'll fill that out look in the chart now the total cost the total interest cost
and this is important for everybody like how much is it gonna cost me to borrow
this twenty five hundred dollars for the year and repay back the total interest
cost is only fifty dollars it's relatively low and this is based on that
four point seven five percent interest rate that we put in so the adjusted loan
amortization is ten months so basically she's gonna have it paid off by the end
of ten months we're gonna look at the loan amortization table we're gonna
click on that and basically what that shows us is that the loan balance is
twenty five hundred the first payment of two hundred thirteen dollars two hundred
thirteen goes to principal zero goes to interest and the loan balance is paid
down then the the next month you still make a payment of two thirteen the
principles one ninety four and the interest is eighteen ninety five so this
eighteen ninety five is actually the interest for both months I don't know
why it's calculating out like that but that's what it's doing third month two
hundred and thirteen dollars the principal two hundred and five eight
dollars in interest this is in the fourth month where Alice has taken her
five hundred dollars extra and she's applied that as an extra payment to the
law so to her payment instead of being two hundred and thirteen dollars is
actually seven hundred and thirteen dollars so she still pays a little bit
of interest but a huge amount goes to the principle which we scroll down to
the bottom and we can see that at month ten or in December the the balance on
the loan remaining is zero and she hasn't invested her $2,500 now let's put
this into a spreadsheet to show the returns on investment so if we go back
to our sheet I've copied and pasted the information from the RBC website see the
payments - thirteen - thirteen - thirteen this larger one to five hundred
dollars more seven thirteen right down to the bottom and the the loan balance
goes down we could see the calculation how much interest is paid works out to
the same what happens with the RSP immediately when she gets the loan she
she owes that money but she takes that money she puts it in the RSP we're RSP
contribution of twenty five hundred now the RSP values twenty five hundred as I
said before they're gonna she's going that's $250 per month 213 plus 36 27
equals 250 so that her her contribution per per month is the same as Bob's $250
so the value is increasing a little bit faster at the end of the year when we
can look at all of these payments she's made a total payment of twenty five
hundred dollars out of pocket over the course of the year of course this
doesn't include the five hundred dollar refund that she got because that was
money that she wouldn't have gotten had she not put in the money into the RSP
the RSP value is it three thousand one hundred and eleven dollars and she is
put in twenty five hundredths so she is effectively made six hundred and eleven
dollars compared to Bob's eighty one dollars there's one other factor that we
have to consider and that's the $2,500 that Bob put in during 2019 in 2020 in
his return he's actually going to get the same $500 back that Alice received
in extra refund and this is kind of a residual thing I'm actually gonna make a
separate video on this well put the link up above when I've got that in there and
you guys can check out that video because it's gonna show the breakdown
the trickle-down effect of the marginal tax rate and the RSP refund that you get
from that anyways I'm gonna show you the quick numbers we're just gonna go
through it basically what happens is each year subsequently if they keep
reinvesting that refund they just continue to get a little bit more of an
extra refund looking at after five years of residual income twenty-five hundred
dollars invested by Alice is worth four thousand five hundred nineteen dollars
the twenty five hundred dollars invested by Bob is worth four thousand four
hundred eighty three dollars the difference is less than forty dollars
difference between the two if we change this rate to zero percent even though
the RSP value was greater at the beginning in this lump sum she's
actually returned less at a zero percent return so the big takeaway from this is
you know but Alice is making a little bit more money she's paying definitely
some interest she actually makes a little bit more return because she's
invested sooner but if the mark it is going down Bob's getting the
benefit of dollar cost averaging and I think for the amount of work that Alice
had to do applying for the loan making sure the loan payments go through
transferring extra money in with her RSP each month and Bob just has a
straight-up contribution I mean I would personally would probably go with Bob's
approach just make that contribution automatic and get rich over the
long-term anyways I hope you guys enjoyed this video remember to hit the
like button down below subscribe if you haven't turned on your notifications
bell and let's get rich together
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