Estimated reading time: 7 minutes
Cashing RRSPs to pay off debt comes with potential financial consequences that you should know about.
Today, finance expert Gary will give us the rundown about cashing in RRSPs to pay off debt.
If you’ve come to the decision to remove your RRSPs, it’s a last-ditch effort to pay the bills.
Finding yourself in this position could mean earning extra cash to increase your net income.
As well, perhaps your budget needs adjusting (if you need one you can get it free here).
Give yourself three months of budgeting at which time it will show areas where improvements can be made.
If you are nervous about budgeting because you’ve never done it, start by reading my 10-Step Mini Budgeting Series.
Implement an emergency savings fund if you don’t have one, and create a plan to build your RRSPs back.
There are many ways to earn extra cash in Canada; you’ll find many tips on the blog.
Let’s see what Gary says about cashing RRSP’s and the costs involved.
Cashing RRSPs Investments And Financial Consequences
I received an email from a CBB reader wondering if it was savvy to cash in his RRSPs to pay off Debt.
He’s not alone, as many Canadians struggle to keep up financially with the rising bills and debt.
Although paying your debt back on time is ideal, some people who have money stashed away in investments may or may not benefit from using that money to pay off their debts.
Should I Be Cashing In RRSPs To Pay My Debt?
Dear Mr. CBB,
I have debt that I need to pay off as the interest rate is high, and I’m not sure if it would be a smart idea to withdraw my RRSPs, which I have been investing in for the past 10 years.
I have $10,000 in debt to repay and about $100,000 in RRSPs invested through my employer and with a personal financial advisor.
However, I did ask him, but I’d like a second opinion, so I thought I would reach out to see if you or someone you know could help with my dilemma.
Thanks,
Craig.
Financial Advice From A Professional
Since I’m not a financial advisor, I sent the reader question to my friend who works in investments.
He was happy to respond to the reader to help him understand and perhaps make an informed decision.
Take it away, Gary.
Should Craig Be Cashing RRSPs To Pay Off His Debt?
My short answer is that it depends.
Read on for an example and my thoughts about cashing in RRSPs to pay off debt.
Cashing RRSPs To Pay Off Debt
Consider several factors if you are thinking about cashing RRSP’s.
- The age of the person
- Withholding tax on the funds withdrawn on the RRSP
- The amount of debt and its’ interest rate
- Type of investment held in the RRSP
- The opportunity cost of the withdrawal
Related: Should you invest in an RRSP, TFSA or Non-Registered Account?
To keep things simple, let me say if you are doing this and are under 30, then it might not be a bad thing.
You have a shorter accumulation period and time at older ages, and the magic of compound interest works against you.
I have always maintained that paying off debt is one of the best investments someone can make.
Suppose you carry 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 owe more than the rate withheld if you have a high income.
Withdrawal Amount Tax Withholding
| Withdrawal Amount | Tax Withholding |
| From $0 to $5,000 | 10% |
| From $5,001 to $15,000 | 20% |
| Greater than $15,000 | 30% |
Withdrawing Money From An RRSP To Pay Off Debt
Below is an example of what happens when withdrawing RRSPs early.
So, let’s assume you have $10,000 in debt.
You pay a minimum of 3% to carry the debt or $300 monthly.
The debt carries an interest rate of 18%.
Approximately $14,300 must be withdrawn to net the $10,000 to pay off the debt.
Your savings, the cash flow of $300 monthly after the debt is eliminated.
However, the real cost may be much greater.
What would the $14,300 be worth at age 65 at a 6% yield if it had never been withdrawn?
If you were 35 when you did this, the monies would be worth, at age 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 $300 a month every month until age 65?
If you did do this, your deposits would be worth $294,354.
In this example, provided you have the discipline to save the $300/month, it might work out to eliminate the debt first.
What if our client could find savings through budgeting and an additional $300 per month?
In 19 months, they would be debt-free, their RRSP would be intact, and now they could save even more toward their future.
Using a Debt Repayment Calculator
This Debt Repayment Calculator is a handy tool that might give you an idea of the information you seek.
First enter $10,000, then 18%, then a monthly payment of $300.
Change the monthly payment to the minimum payment and then see what happens.
This shows the real cost of paying credit cards on a minimum payment basis.
Double the payment to $600 from $300 and again see the payment plan’s results.
Ideally, this would be the preferred course of action, but not everyone has this kind of money.
This would be a great debt repayment calculator to bookmark if you have a debt to pay back. (not sponsored)
If your RRSPs are earning low rates of return, such as 2% or 3%, it is 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.
Before cashing in RRSPs, talk to your financial advisor and for savings through budgeting to help keep the RRSP intact.
So there you have my analysis on whether you should be cashing RRSPs to Pay Off Debt!
Discussion Question: What would you do in this situation?
Leave me your comments below.
Related: Should I split my RRSPs with my spouse if we get a divorce?
Mr.CBB
Note: This post was written in 2012, so use the information as educational material.
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.
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!
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.
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.
Thanks for the comments everyone. In most circumstances it is not wise to use your RRSP as an emergency fund.
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.
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….
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.
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……