The advertising always tries to grab your attention by stating that by loaning money you can get a good fraction of it back from the government when you file your income taxes and some people probably use this to rationalize making a loan. Unfortunately, the true financial value of the tax credit is worthless. I won’t get into why in this post, but some fellow wrote about it here and it is a much better way of thinking about one’s RSP than what is otherwise intuitive – his reasoning is not intuitive, but it is correct.

I have always wondered why anybody would ever bother doing an RSP loan from a rational perspective and the scenario that comes into mind deals with a high-income individual that has their cash flows so lumpy that they will only receive it after the March 1, 2010 contribution deadline and where this person’s balance sheet is in such crummy (or illiquid) shape that they cannot pull out non-taxable reserves into the RRSP umbrella. It would also imply their cash management in prior years is equally crummy since they failed to save enough money to pay for the RRSP.

Such people are likely to have high levels of debt, which highly suggests they should be putting their cash into their debt. However, in the event that their debt has a low interest rate, then the RRSP loan would make sense.

In other words, the number of people that truly need RRSP loans are next to none. I can’t fabricate a real life scenario where somebody working a full-time job would want to loan money for an RRSP.

Ever since the advent of the TFSA, the retirement savings game has changed considerably – although there are exceptions to every rule, if I had to make a “one rule fits all” criteria for RRSP vs. TFSA contributions, the math highly suggests the only people that should ever be considering to make a contribution in an RRSP are those making more than (note: 2010 year) $81,941 a year, which is where the 26% federal tax bracket kicks in. Otherwise you should contribute money to your TFSA first, and then your RRSP with any leftover amounts you have left to save.

If you make less than $81,941 a year, your first dollars should go to your TFSA and then if you have money left to save, into your RRSP. In no way should your net taxable income go below $40,970 – you can still contribute to your RRSP, but you should wait until a future year where you make more than the lowest bracket to actually deduct the income.

Taking out an RRSP loan to defer the income tax is financially foolish, especially since the interest on the loan is not tax-deductible. The only exception I would make is if you are supremely confident you will be able to make more than the loan interest on an after-tax basis (so let’s say you are in the 40% tax bracket and your RRSP loan is at 3% interest; you would need to make 3%/(1-0.4) = 5%) but I do not think this is appropriate for most and that taking an RRSP loan is functionally equivalent to borrowing money in a brokerage account to invest. The only difference between an RRSP loan and borrowing to invest on margin is that at least when you borrow to invest on margin, you can deduct interest expenses from your income tax.

Anybody with an RRSP in ING Direct would do well to lock in the 90-day rate as soon as they can; even though they stated they will offer it until March 1st, they could revoke it. The difference between a 3% rate and a 1.25% rate (which is more representative of the current market rate for a 1-year GIC) is $43.15 on a $10,000 investment. It is not huge money, but it is more money nonetheless.

The 3% TFSA offer is quite a lure, but it is designed to trap as much money before they reset the rate back to a lower rate. The trick with the TFSA is that once customers have deposited their money into the TFSA, it is a lot of unnecessary paperwork to get their money out of the TFSA account once the rate resets to something lower. If customers decide to withdrawal the TFSA once the rate goes lower, then they lose the contribution room into their TFSA until January 1, 2011.

For those people that want to keep their money in a risk-free instrument (e.g. a GIC), use the ING Direct TFSA at your own peril. As a matter of financial planning, the TFSA should not be used as a risk-free account anyhow, but some people will want to use it to park idle cash.

ING Direct used to be the undisupted best place to save money, but over the past few years they have become just “normal”. They are still excellent with respect to having a no-fee operation and this works to their benefit – if money is easy to get out of them, then I feel much safer keeping money with them. For matters such as RRSP and TFSA transfers, however, there is a real bureaucratic cost associated with these and it is not worth it to capture an extra 0.5% elsewhere for the dollar amounts in question that people typically deal with.

If ING Direct wanted to raise a lot of longer duration capital, they’d do fairly well if they offered a 5% 5-year GIC.

If you withdraw the $5,100 on January 1, 2010, you will have to wait until January 1, 2011 in order to be able to bring the $5,100 of capital into the TFSA tax shield.

The true value of the TFSA won’t be felt until years later when everybody will have contribution rooms sufficiently high that you will be able to shield considerable amounts of savings – assuming interest rates ever rise to respectable levels again (e.g. 5%), in 10 years, you will be able to shield $50,000 at 5% interest, or about $2,500 of tax-free income a year. This essentially will create a risk-free situation for most ordinary people to shield interest income from the government.

The TFSA is truly a financial instrument of lower-income Canadians, while the RRSP is the preferred vehicle for higher-class Canadians. Unlike the USA Roth IRA, the Canadian TFSA is a heck of a lot more flexible – you do not have to wait until you are 59.5 years old to withdraw funds without tax penalty.