Cashing In Your RRSP’s Investments May Follow With Financial Consequences
I received an email from a CBB reader wondering if it was savvy to cash in his RRSP’s to pay off Debt.
He’s not alone as many Canadians are struggling to keep up financially with the bills and debt continues to rise.
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 clear their debts.
Should I Cash In My RRSP’s?
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 RRSP’s which I have been investing in the past 10 years.
I currently have $10,000 in debt to repay and about $100,000 in RRSP’s that have been invested through my employer and with a personal financial advisor.
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 out with my dilemma.
Since I’m not a financial advisor I send off the question to my friend who works in investments and he responded below with his feedback.
Take it away Gary.
Should Craig cash in his RRSP’s to pay off his debt?
My short answer is that it depends.
Cashing your RRSP’s To Pay Off Debt
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- The withholding tax on the funds withdrawn on the RRSP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 per cent 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 per cent 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.
Withdrawl 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%|
Example Of Withdrawing Money From An RRSP To Pay Off Debt
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/month 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.
Using a Debt Repayment Calculator
This Debt Repayment Calculator is a handy tool that might give you an idea of the information you are looking for.
First enter $10,000, then 18%, then 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 what the results are of the payment plan.
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.
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 or cash in your investments if you needed the money?
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