Withdrawing from RRSP to Pay Debt?

In some cases, withdrawing from an RRSP can be a practical solution to turn to if your concern is just to pay off debt. Always speak with a trusted advisor first as there are other options to consider instead.

When to liquidate an RRSP and the effect it will have on you?

When to Liquidate?

Everyone’s situation is different to consider when withdrawing from their RRSP to pay a debt but here’s a simple example. I’ve left out some details to simplify.

Simple Example:
Colin is a 30-year-old, single male.
He has about $30,000 in credit card debt, and income is $26,000 annually.
His debt payments are $1000 a month for his credit card payment alone, and he is not making any headway.
It will take him 18 years with payments of $1,200 to pay off his $30,000 of debt.
So far he has about $20,000 saved in his RRSP.

Colin does not have an ideal situation, but it happens to more people than you think. What you’ll need to ask yourself is, does it make sense to pay his credit card $1200 for 18 years and not contribute anything for savings? If he spends $20k from savings now, he’ll only need to pay $1000 for 12 months before he is debt free. Then he can enjoy 34 years of RRSP savings.

What are the Effects On Me?

1) RRSP have a maximum amount that can be contributed every year until age 65*. Liquidating them will allow you access to your capital now. However, your maximum contribution room is lowered by what you withdrew.

Simple Example:
Colin is a 30-year-old, single male.
He has about $30,000 in credit card debt; income is $26,000 annually.
His debt payments are $1000 a month for his credit card payment alone, and he is not making any headway.
It will take him 18 years with payments of $1,200 to pay off his $30,000 of debt.
He decides to withdraw from his RRSP to pay down a portion of his debt.
So far he has about $20,000 saved in his RRSP.
Colin can contribute 18% of his income ($9,000 annually) to an RRSP every year until age 65.
He is 30 now and can contribute until he is 65.
65-30 = 35
What he will not be able to do is recontribute the prior years $20,000 contribution.

Note: I used Bankrate.com & thecalculatorsite.com for the numbers.

2) How much tax will I pay?
Before withdrawing RRSP to pay off debt have a chat with a good accountant or advisor but here’s the basic idea. First, calculate if you can save enough by doing this. Compare the amount of interest you’re paying on your debt now vs. the withholding taxes & the amount is withdrawn that needs to be included in your tax and benefit.

Look at the amount that you withdraw and see if this puts you into the next tax bracket.
Year Personal Amount Canadian federal marginal tax rates of taxable income

Year Personal Amount Canadian federal marginal tax rates of taxable income
2017 $11,635 $0 – $45,916 $45,916 – $91,831 $91,831 – $142,353 $142,353 – $202,800 over $202,800
0% 15% 20.5% 26% 29% 33%

So for example, if your income is $45,282 (this is the maximum for this bracket) and your taxes are 15%. Then you withdraw $10,000 from your registered plan. CRA would look at this as your total income for the year. This totals as $55,282 and CRA will tax you at the next bracket up 20.5%. Therefore you can end up owing 5.5% more if you withdraw enough to enter the next bracket.

In Colin’s case, he has $26,000 income per year. If he withdraws $20,000, then CRA will this as income he made for the year.
$26,000+$20,000 =$46,000.

So let’s look at $20,000.
15% of $20,000 is $3,000.
He’ll receive $17,000 approximately if he chooses to withdraw.

 

Is Liquidating RRSP a Good Idea?

Have a good discussion with your financial planner. The example with Colin is relatively straightforward however there are more details & ways to discover with a good conversation about your goals. Work fast, and you’ll be able to retire comfortably with less headache.