Reader Question: Is It Savvy To Cash In My RRSP’s To Pay Off Debt?

6 simple ideas to generate cash money whe you're broke

ONE OF THE HARDEST FINANCIAL DECISIONS OF YOUR LIFE MIGHT BE WORTH IT

 

A reader question about whether it was savvy to cash in an RRSP to pay off Debt was submitted to Mr.CBB. He forwarded it to me to share my opinion on this topic with all of you.

My short answer is that it depends.

 

Cashing your RRSP’s

 

There are several factors to consider if you are thinking about cashing your RRSP’s.

  • The age of the person
  • The withholding tax on the funds withdrawn on the RRSP
  • The amount of debt and its’ interest rate
  • The type of investment held in the RRSP
  • The opportunity cost of the withdrawal

To keep things simple let me say if you are doing this and are under 30 then it might not be a bad thing. At older ages you have a shorter accumulation period and time and the magic of compound interest work against you.

I have always maintained that paying off debt is one of the best investments someone can make.

Let’s say you’re carrying a credit-card balance of $1,000 with 18 percent simple annual interest. That’s $180 a year in charges. Pay off that debt and you’ve saved $180. That’s the same as investing $1,000 in something that earns an 18 percent return after tax.

 

Tax withholding rates

 

When you withdraw funds from an RRSP there is a tax withholding. This is a credit due for taxes payable on 100% of the withdrawal and is to be paid by April 30th in the year following the withdrawal. You may indeed owe more than the rate withheld if you have a high income.

Withdrawal Amount Tax Withholding
From $0 to $5,000 10%
From $5,001 to $15,000 20%
Greater than $15,000 30%

So let’s assume you have $10,000 in debt. You are paying the minimum of 3% per month to carry the debt or $300 per month. The debt carries an interest rate of 18%.

Approximately $14,300 needs to be withdrawn to net the $10,000 to pay off the debt. Your savings, the cash flow of $300 per month after the debt is eliminated.

However the real cost may be much greater.

What would the $14,300 be worth at age 65 at 6% yield if it had never been withdrawn?

If you were 35 when you did this, the monies would be worth at 65, $83,281 so you are giving up potential growth on this money in addition to the withholding tax.

Ok, I hear the question already: What if we withdraw, pay off the debt, and invest the $300 a month every month to age 65?

If you indeed did do this, your deposits would be worth $294,354. In this example provided you have the discipline to save the $300/mo. it indeed might work out to eliminate the debt first.

What if our client was able to find savings through budgeting etc. and find an additional $300 per month?

In 19 months he/she would be debt free, their RRSP would be intact, and now they can save even more toward their future.

This Calculator is a handy tool. First enter $10,000, then 18%, then monthly payment of $300.

Under step 2, choose minimum payments. This shows the real cost of paying credit cards on a minimum payment basis. On page 2, change the monthly payment to $600. See the result? You may want to bookmark this calculator.

Ideally this would be the preferred course of action.

If your RRSP’s are earning low rates of return, such as 2% or 3% it makes it easier to withdraw monies and eliminate the debt. Your opportunity cost (Put another way, the benefits you could have received by taking an alternative action.) is not very great because of the low yield on the investment.

So there you have my analysis on whether you should cash in your RRSP’s to Pay Off Debt!

Discussion Question:

Would you pay off the debt first?

Look for the savings through budgeting and keep the RRSP intact?

Post Contribution: What kind of written plan do you have for retirement that ensures you won’t outlive your money? I help people answer that question CONTACT INFORMATION: (905) 202-8430 ext.626 ggorr@ifcg.com

Do you have a story or a question you’d like to share on CBB? Email me at canadianbudgetbinder@yahoo.ca

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Mr. CBB
Mr. CBB was born and raised in the United Kingdom who then moved to Canada where he is a permanent resident. He recently became a father to a very busy toddler who allows him to be a kid at heart. He bought his first house at the age of 21 after University and his second at the age of 24. Both Mr.CBB and his wife are Debt and Mortgage Free and they did it all in under 5 years using a Budget. Canadian Budget Binder is a place where he shares their financial experiences with his readers and hopes to learn about theirs. Welcome to CBB!
Mr. CBB
Mr. CBB

Comments

  1. Christine Weadick says:

    We had to cash in a number of the RRSP’s we held as my husband fell off the roof in Sept 2009 and was off work for 10 months……..it’s called survival. We still haven’t recovered form that and it looks like we never will at this point. He’s been off work now for the last year due to illness, I can’t work right now as I’m caregiver and sole driver. He’s 57. We applied for and are getting Canada Pension Plan- Disability and Ontario Disability Supplimental Plan. It’s keeping body and soul together and that’s it……

  2. Certainly if the situation was desperate enough then it is better to withdraw the money and use it. But in generally, I think its best for people to keep their hands off the RRSP and let the money grow.

  3. Agreed, I think it depends, personally if I had any RRSP contributions that could eliminate my debt I would do it but I’m young and would have many years to repay it. The thing to think about is the stress factor on your life the debt-load is carrying as well. You quality of life may drastically improve if you pay it off….

  4. I’m not familiar with the rules for RRSP accounts, but is there a penalty for early withdrawal? Regardless, I would use that as a last resort. Most people not disciplined enough to put the money that was being used for debt repayment toward investing.

  5. Thanks for the comments everyone. In most circumstances it is not wise to use your RRSP as an emergency fund.

  6. John S @ Frugal Rules says:

    I agree with you entirely. I think that it does depend on the situation. You have to look at the rate you’re earning in your investment vs. what you’re paying on the debt. You also need to look at the type of debt it is. Is it a fixed lower rate like student loans, or is it something more variable like a credit card. There are various factors that have to be looked at. Another one is the issue of time. Personally, I think in general I’d be looking to either cash some out and pay off the debt or make some changes to my budget that would allow me to pay off the debt. I hate debt, so I am a bit biased and would probably look to what I could do to become free from it.

  7. Canadian Performer's Money says:

    I think a lot of people I know are way to quick to cash in their RRSP or other investments in order to pay off debt. Once you get in the habit, I fear you will turn around when you are in your 60’s and realize you have little to no savings.

    A few years back work slowed down for me and I was having trouble keeping up with payments on a condo I owned. Instead of cashing in my RRSP I got a job 2 days a week delivering pizzas. While I felt a little degraded moping up floors in a pizza joint, I reminded myself that being financially independent means putting in some hard work every now and then.

  8. Great article Gary! Coming from the Mortgage side of things, I would also point out that this person may lose the opportunity to use those RSP funds as a down payment down the road, which could impact the timing of when they could buy their first home. People need to review decisions like this in detail and be aware of the impact later on. Cheers!

  9. I have not used my RRSP to pay debt but I have used it towards a down payment on my home and I also borrowed from my RRSP to buy back my mat leave for my OMERS (pension plan). My hubby used his RRSP to pay debt but he did this before he was 30 so we hope it didn’t do too much damage.

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