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.
Here’s why:
- 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 an expert accountant. He 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 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.
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.
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.
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 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.
Filing Taxes 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. For advice and assistance with tax planning, a CRA tax dispute, or other tax issues, get in touch with Filing Taxes today to see how we can help. Experts at Filing Taxes will be happy to assist business owners in this pursuit. To speak with an experienced accountant, contact Filing Taxes either at 416-479-8532 or [email protected]. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.