Is It Worth It Paying Down Your Debt with RRSPs? | Raymond Chabot (2024)

In short

Withdrawing your RRSPs before retirement has consequences :

• A portion of the amount withdrawn is withheld at source : at each withdrawal, you will pay withholding tax.
• Exit fees may apply : based on the type of investment held, your financial institution may require liquidation fees.
• You will pay income tax : the amount withdrawn from your RRSP could move you into a higher tax bracket.
• You could jeopardize your retirement : by withdrawing funds from your RRSP before retirement, you’re only postponing your debt problems.

Except for those exceptional situations, dipping into your RRSPs is rarely a good idea. There are other solutions to indebtedness. Talk to a trustee!

RRSPs were created to allow you to save for retirement tax-free. If you withdraw before time to find a solution to your debt, there will be consequences :

A portion of the amount withdrawn will be withheld at source

Every time you will make a withdrawal, you will pay a withholding tax that varies based on the amount withdrawn and your province of residence. To give you an idea :

• If you withdraw $5,000, the withholding rate will be 10%;
• If you withdraw between $5,001 and $15,000, the withholding rate will be 20%;
• If you withdraw more than $15,000, the rate will climb to 30%.

Naturally, when you decide to withdraw your RRSPs, you will have to take this withholding tax into account in the total amount that you want. For example, if you withdraw $5,000, after the amount withheld of$1,050, you will only have $3,950left to pay down some debt. If you need $5,000, you will have to withdraw$6,750.

You may have to pay exit fees

Depending on the type of investment that you have (particularly, funds), your financial institution could ask you to pay exit fees. Also, the longer you have been a member of the investment, the less you will pay.

You will have to pay income tax

Your withdrawals will have to be reported on your tax return as income. If your total taxable income reaches the upper limit of a tax bracket, the amount you withdraw from your RRSP could cost you by moving you into a higher tax rate.

For example, if you earn $30,000per year and you withdraw $15,000from your RRSPs, your total earnings will be $30,000 + $15,000 = $45,000. You will therefore move into the 20% tax bracket when you were previously in the 15% one.

You will lose contribution rights

By dipping into your RRSPs, you will lose contribution rights to which you had previously been entitled. When you will have settled your financial worries, you will not be able to replace the amounts withdrawn from your RRSP.

You can jeopardize your retirement

The main objective of RRSPs is to provide savings for a comfortable retirement. If you take out RRSPs before getting to this stage of your life so that you can pay off debt quickly, will you have enough money in your golden years? By paying down debt today using your RRSPs, are you not simply postponing the issue? And, don’t forget, at retirement age, you may no longer be able to work. Your income will therefore be less. If you have debt then, you will be in an unfortunate position, and you will no longer be eligible for debt consolidation.

Your RRSPs are protected in the case of personal bankruptcy

Remember also, that if you declare bankruptcy, your RRSPs will be untouchable (except for contributions made in the last 12 months preceding the bankruptcy). Your retirement is therefore protected. Even if you’re not there yet, it’s best to prepare for the worst case scenario.

There are 3 exceptional situations where you could dip into your RRSPs  

There are actually three situations where you could withdraw your RRSPs before retirement.

• You want to buy a house and you haven’t been an owner in the last five years: the Home Buyer’s Plan(HBP) allows you to withdraw up to $35,000 from your RRSP tax-free. You must however pay back the amount withdrawn in the next 15 years;
• You want to go back to school: the Lifelong Learning Plan (LLP) allows you to withdraw up to $20,000 from your RRSPs over a period of up to four years;
• You have low income: You’re unemployed or on sick leave. As your earnings are low, withdrawing from your RRSP might be worth it because your tax rate on the withdrawal of your RRSPs will not be high and you will pay little tax.

Other solutions to indebtedness  

As we just saw, dipping into your RRSPs can be done in certain exceptional situations, but it should never be your first choice. There are other solutions for getting out of debt, such as revising your budget, consolidating your debt, the consumer proposal or bankruptcy. A licensed insolvency trustee such as those at Raymond Chabot can help you identify which option is the best for you. Don’t hesitate to call on an expertto eliminate your debt once and for all!

You have financial worries? Contact one of our licensed insolvency trustees. They will guide you every step of the way.

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