Read This Before Cashing Out Your RRSPs To Pay Debt

When Does It Make Sense To Cash In RRSPS?

It's usually pretty easy to cash in RRSPs before retirement. In fact, the government seemingly encourages use of RRSP savings in some cases by shielding withdrawals from taxation, subject to re-payment, through the Home Buyer’s Plan (HBP) and the Lifelong Learning Plan (LLP). If you're confident that you'll have the opportunity to re-build your retirement savings before you need them, using these savings might make sense. However, we don't advise cashing in RRSPs without first considering the following ways this can impact your financial situation.

Impacts To Consider

Immediate tax consequences

RRSP withdrawals are treated like income, so you'll have to pay tax on the funds you receive. When you withdraw the funds, a portion (based on a set formula) will be withheld to cover the estimated taxes. But the amount withheld isn't always enough to cover the tax that's actually owing on this extra “income”. When tax time comes, you may find that you owe more than you anticipated, especially if your income from other sources was relatively high during the period.

We've seen situations where an individual has withdrawn RRSPs to make a payment on their debt to keep creditors at bay, only to end up with a new creditor: Canada Revenue Agency (CRA). The CRA has powerful collection tools like being able to garnish wages or file a property writ without a court order, so new tax debt can result in the individual’s debt situation being even harder to manage than it was before the RRSPs were withdrawn.

The future retirement consequences

If you withdraw from your RRSP savings for any reason other than the HBP or LLP, you lose contribution room in your RRSP, which means you might not be able to make up for it later and still get the tax sheltering. This is only an issue if you're going to be able to save enough for the contribution limit to come into play. If you never get close to the contribution limit, this might not make a difference for you.

The thing that will make a difference for anyone withdrawing from their RRSPs is the reduction in the amount available when it comes time for retirement. It's not just the amount you withdrew that you will be missing out on, but also the compounding returns on that withdrawal amount, which could be massive. If you don’t save enough money to live on in your retirement, you may regret your decision to withdraw the funds in the future.

Liquidating an exempt asset

The decision to cash in RRSPs to pay down debt is often made under duress. In addition to their personal desire to pay back their debt, individuals often face a high pressure campaign from debt collectors. They are often not aware that their creditors likely cannot seize their RRSP savings even though those creditors may be threatening to go to court and/or seize assets.

There are certain assets that have been made exempt from seizure by federal and/or provincial law, and RRSPs are one of those, subject to some exceptions dependent on which province you live in; in Alberta, RRSPs are generally exempt. This is a policy decision made by the government, as they recognize the importance of individuals being able to care for themselves in their retirement regardless of their debt situation.

So while using savings to pay down debt can sometimes solve debt problems while allowing the individual to keep up a good credit score, in other cases such as using RRSPs to simply hold off creditors when the debt is altogether unmanageable, it may not be the best plan. For instance, in the event you end up having to make an insolvency filing, you would likely be able to keep your RRSP savings even while your debt is discharged.

Get Advice

If you can pay off all of your debt and re-build your retirement savings before you need them, using your RRSP savings to pay your debt might be a good idea. However, you should probably get some advice before you do so, as it may not provide the debt relief you are looking for and can actually make your situation worse. A Licensed Insolvency Trustee can review your options for dealing with your debt and talk to you about the consequences of cashing in RRSPs. If you are considering cashing in RRSPs for any other reason, talk to a trusted advisor before taking this step to be sure you fully understand the consequences of accessing these funds.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly help individuals navigate their options for dealing with overwhelming debt. If you would like a free, no-commitment consultation to review your options, contact us.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.