Have you considered withdrawing from your RRSP or other retirement savings plans to pay down your debts? Have you thought of using your RRSP to take a vacation or as a ready source of cash?
Withdrawing from your RRSP early can have some unintended tax consequences. There may be alternatives to using your regular or self-directed RRSP for debt reduction or other ways to access cash you may need.
RRSP Withdrawals & Income Taxes
The financial institution that holds your RRSP is required under to withhold a portion of the withdrawal for income tax. The RRSP withholding taxes are as follows:
RRSP Withholding Taxes
|RRSP Withdrawal||Withholding Tax|
|up to $5,000||10%|
|$5,001 to $15,000||20%|
|$15,001 and up||30%|
In Quebec, the withholding rate is ½ of the percentages in this table.
For example, if you have $20,000 of debt, you would need to withdraw at least $28,600 from your RRSP ($28,600 – 30% = $20,020).
Although, you may be thinking that you could reduce the amount of withholding tax to 10% by doing four $5,000 withdrawals, you may be doing yourself more harm than good.
The withdrawals from your RRSP are added to your taxable income and the withholding tax may not be enough to offset the extra tax that is actually due on the withdrawal. You could be hit with a tax bill at the end of the year!
Also note that some financial institutions are looking at clients who have made multiple RRSP withdrawals and may require the higher withholding rate be applied!
Jim earns $40,000 and needs $20,000 to pay off his debt.
If Jim does a lump sum withdrawal of $28,600 he will receive $20,000 to pay off his debt.
At the end of the year, Jim’s employer would have remitted $6,400 of tax for his employment income and the bank would have withheld $8,600 for his withdrawal.
His taxable income would be $68,600 and would still owe $360 to the government as a result of the withdrawal.
On the other hand, if Jim decided to do four withdrawals of $5,600 each, the total tax withheld would only be $2,200. At the end of the year Jim would owe the government an additional $5,300!
Are There Alternatives To Withdrawing From Your RRSP?
I am of the opinion that an RRSP you should never withdraw from your RRSP to pay down personal debt! Think about the following alternatives to withdrawing from your RRSP:
- RRSPs & RRIFs are Creditor Protected. If you find yourself unable to pay your creditors, you may be facing bankruptcy. Know that if you go into bankruptcy, RRSP contributions made more than 2 years prior to bankruptcy cannot be touched by your creditors.
- Consolidation Loans. If you still have good credit and are finding that your debt payments are getting out of control, consider consolidating your debts into a single payment. The single payment should be lower than your combined payments and the term of the loan is fixed (so there is an end in sight). If you consolidate, take steps to eliminate your credit cards and other lines of credit so you don’t find yourself in this situation again.
- Consumer Proposal To Creditors. If you are unable to get a consolidation loan, you should consider seeking the help of a consumer credit counsellor and make a proposal to creditors. The proposal can reduce the amount you pay and avoids bankruptcy. However, a consumer proposal will show on your credit report and affect your credit rating for 3 years.
- Bankruptcy is a process of eliminating your debts. With bankruptcy personal assets may be sold to satisfy all or some of your debts. Contributions made your RRSPs more than two years ago will be exempt from your bankruptcy and certain other personal assets (varied by province).
- RRSP Mortgage: If you are thinking of paying down your mortgage with your RRSP, consider an RRSP mortgage instead. The RRSP mortgage allows you to hold your own mortgage inside of your RRSP. In the end you are paying off yourself!
- Education Withdrawals You can withdraw under the Life Long Learning Plan (LLP) tax free as long as you pay it back later on.