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When facing debt, many Canadians think that cashing out their investments to pay out their debt is a good idea. Unfortunately, the truth is that cashing out the funds in your RRSP to cover your debts is not ideal.
- If you use your Registered Retirement Savings Plan (RRSP) funds to cover a debt, you will have to start saving for retirement from scratch all over again with less time to do so.
- By tapping into your RRSP before you retire, you will miss out on the chance to grow your money with the help of your plan’s compound interest.
- The money in your RRSP has been deducted from your annual income and is not taxable as long as it remains within the RRSP. However, the amount you take out of the RRSP is fully taxable, so a percentage of it will be held back to pay for income tax. As a result, withdrawing money from your RRSP will create a new tax debt that you will have to cover once you file your income taxes.
- When you withdraw money out of your RRSP and use it for anything else except purchasing your first home or for retirement, the funds are subjected to a withholding tax. This means that you will not receive the entire sum you withdraw, so you will have less money to cover your debts and will have lost part of your savings to the government.
What A Person Should Do Instead of Using RRSP
If you’re struggling with debt, your best option is to consult a Licensed Insolvency Trustee (LIT). The LIT will review your financial situation and help you come up with a plan to deal with your debts.
Withdrawing money from your RRSP may seem like a quick fix for your debt problem, but doing so may hurt your financial situation in the long run. Filing for a consumer proposal or a bankruptcy can eliminate your debt without affecting most of your long-term investments.
Filing for a consumer proposal or for bankruptcy to eliminate your debt also helps you rebuild your credit score. This can open up more financial opportunities for you in the future, whereas using your RRSP funds to cover your debt only damages your financial situation in the long run.
Remolino & Associates takes a personal approach to debt solutions. We take the time to study and understand your financial situation, and provide you with debt relief options that will benefit you the most.
We offer free, no-obligation consultations. Contact us today and take the next steps toward tax debt relief
Should You Use Existing Assets To Pay Off Debt?
Selling some of your assets may help you solve your debt problem. If you own something of value that you no longer need, such as an older car or an unused property, it makes sense to sell it and use the funds to pay off your debt.
The same goes for most investment accounts other than an RRSP as well. Using those assets to pay off your debt may be a good idea because the interest rate on your debt may be higher than your accounts’ return on investment.
But if you rely on those assets for your job or financial security, it may be better to keep them. Your RRSP is a guarantee that you will live comfortably when you’re older, so you shouldn’t risk your future financial security for a temporary problem like debt.
Plus, the funds you withdraw out of your RRSP are taxable, so you will have to withdraw a larger sum than what you really need. In Ontario, your financial institution will withhold 10% of the sum you withdraw less than $5,000 from your RRSP, 20% for all withdrawals between $5,000 – $15,000, or 30% for withdrawals over $15,000. So you’re losing a large part of your money for every withdrawal.
For example, an Ontario resident who wants to take $44,000 out of their RRSP will have to withdraw $81,000 before tax. In addition, they will also lose the money resulting from their plan’s interest rate, say 4%. A 4% return on your $81,000 investment means a loss of $3,240 per year you would add to the $37,000 you would pay as tax to withdraw the money.
In conclusion, most people would be better off not using their RRSP funds to cover their debts.
Tax Costs Of RRSP Withdrawal
Whenever you withdraw from your RRSP, you have to include the sum you take out in your income and pay tax on it at your marginal tax rate. Because the money in your RRSP is fully taxable.
Your RRSP is a long-term investment that works in the same way for everyone. You contribute to the RRSP while you’re of working age and are included in a high tax bracket, and you should take the money out when you’re retired and are included in a low tax bracket.
The RRSP was specially designed to enable Canadian citizens to live comfortably in their old age. But if you want to tap into your RRSP funds while you’re still working and in a high tax bracket, you have to give a large part of that sum to the state.
Ontario residents who want to withdraw less than $5,000 from their RRSP will pay 10% of the sum as a tax on withdrawal. But at the end of the year, they will also have to pay tax according to their tax bracket. So besides paying 10% on withdrawal, they will also have to pay the difference. For example, a person who is in the 40% tax bracket will have to pay 30% of the sum they’ve taken out at the end of the year, in addition to the 10% paid upfront.
When Should You Use Your RRSP
You can tap into your RRSP funds to pay for your first home. You can withdraw up to $35,000 from your RRSP and use it as a down payment for your first home thanks to the Home Buyers’ Plan. Once you do so, you get a maximum of 15 years to pay back the sum, starting two years after you made the withdrawal.
You can also use your RRSP funds to finance your education. The Lifelong Learning Plan allows you to withdraw funds from your RRSP to pay off your school taxes or any other fees related to your education. This plan allows you to withdraw a maximum of $10,000 per year for a total of $20,000. Once you do so, you get a maximum of 10 years to repay the sum you withdrew.
When You Should Not Use Your RRSP
You shouldn’t use your RRSP to pay your debts. If you’re struggling with debt or are behind on your bill payments, there are other options that can help.
Filing a consumer proposal or for bankruptcy can help you get out of debt without affecting your RRSP. According to section 67 of the Bankruptcy & Insolvency Act, all the contributions to your RRSP except for those you made in the last 12 months are protected if you file a consumer proposal or personal bankruptcy.
Contact a Licensed Insolvency Trustee and get a free consultation. Tell the LIT the details of your financial situation and examine your options together. Your LIT will examine your financial information and help you find the best solution for your financial problems.
Debt is a temporary problem, and we can help you overcome it.
Contact one of our LITs and find out how you can get out of debt today. We offer free, no-obligation consultations. Contact us today and take the next steps toward tax debt relief