Cash Out Your RRSP And Pay Down Debt?

by Tax Guy - Burlington Accountant on February 11, 2011 Print This Post Print This Post

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 WithdrawalWithholding Tax
up to $5,00010%
$5,001 to $15,00020%
$15,001 and up30%

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!

An Example

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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).
  5. 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!
  6. Education Withdrawals You can withdraw under the Life Long Learning Plan (LLP) tax free as long as you pay it back later on.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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{ 49 comments }

Your Insurance Guy November 20, 2009 at 3:09 am

Hello everyone,

I have a client who wants to cash in all his RRSPs in a 7 year period which relates to when he’ll begin drawing a pension, to prevent further taxation on his pension + RRIF income + OAS CPP etc. My question is this: All term certain annuities don’t allow RRSPs to be invested for period of 10 years if you’re under 55. All GIA accounts and RRIFS are paying peanuts unless you have $1 million, and most GIA accounts have market value adjustments, which also means the clients make less money. Do you know of any affective strategies people are doing today to get around this and make a pretty good return?

Please email me your comments.

Your Insurance Guy (yourinsuranceguy@rogers.com)

Tax Guy November 21, 2009 at 6:16 pm

@ Your Insurance Guy:

The risk tolerance of your client will help determine which investments are suitable. There are other investments other than GIA’s that yield higher returns (I currently hold a Manulife Bond with close to 8% yield).

A meltdown strategy would only make sense if the client expected to be in a higher income range in retirement. However, CPP and OAS plus his pension will propbably brign him under his current income.

Robert March 10, 2010 at 12:32 pm

To follow up on the ‘cash out RRSP’ thought, what about this scenario (hypothetical, of course)……
I have ~$35,000 in credit card debt. I also have ~$40,000 in RRSP (mutual funds). Would it make sense to cash out the RRSP to pay off the debt, and then use the $1000 per month I am currently spending on the credit cards to put back into the RRSP? I would be back to my $40,000 level within 3 years, and saved the interest charges for that time. Also, even though I pay tax on the initial withdrawal right now, I would gain it back through the amounts I put into the RRSP over the next 3 years, so the net effect is $0.

Is this correct, or am I missing something?

Tax Guy March 10, 2010 at 2:15 pm

@Robert: The $40,000 would be included in your income for tax purposes and 40% would be withheld. Only $28,000 would be available for debt service and you would have to still pay off $7,000 of debt. You may also have a tax liability as the 30% withheld may not have been enough (it really depends on your taxable income).

You have also lost $40,000 of RRSP contribution room you may never get back and you would need to ensure you make more than $66,000 per year (or have unused room available) to be able to contribute $1,000 a month.

Assuming a return on the RRSP of 7% and 20% rate on the credit card. If you used the $1,000 a month to pay down the credit card it would take 53 months to pay it off and at the end of that period the RRSP would be worth $52,000.

Instead, if you cash out the RRSP, use the $28,000 to pay down the credit card, and use the $1,000 to pay off the remaining debt then contribute to the RRSP, the RRSP would be worth $51,300 after the same period of time.

Of course the above ignores the tax consequences, but I’d say pay off the $35,000 a $1,000 month and at time and after it’s paid contribute to the RRSP. You may be able to make a catch-up RRSP loan and use your excess contribution room.

Robert March 10, 2010 at 3:22 pm

Many thanks!!

Stephanie Michaels March 11, 2010 at 5:54 pm

I read the dialogue on cashing in RSPs to pay off debt, and the tax implications alone might be enough to scare me away from doing this, but I have a question.

The last year has been very hard on me because my RSP investments are really small — too small to ever turn into an annuity. When I retire with my employer pension in a few years, I’ll be 55. I’ll still work somewhere, but I’ll likely earn a fraction of what I earn now. I know taking out my RSPs then won’t hurt so bad tax-wise, but I’ll have lost a lot of money to interest payment on debt.

Given that there is no guarantee that some market meltdown won’t eat up another third of my meager RSP savings, maybe I’d be better off paying the government to waste my money, pay less in interest to the banks who don’t need my money and just getting by with my pension and supplemental employment.

The scenario about the $40k in RSP and $35K debt would be close enough to my own. Is this all just a matter of how well I’m willing to tolerate risk over the next 4 years until I retire?

Thanks. I’ve appreciated the conversation on this topic very much.

Tax Guy March 12, 2010 at 1:32 pm

@Stephanie: My discussion with Robert assumed a relatively conservative rate of return of 7%. So risk is moderate. If you are going to retire in a few short years, it may make sense to cash out the RSP and pay down the debt. You can easily estimate the tax short fall. My biggest issue with the strategy is using your retirement savings for debt and giving up RRSP contribution room. If you are going to retire in the next few years, the situation is a little different: Your time horizon is shorter and you should retire as debt free as possible.

Financial Power March 12, 2010 at 3:28 pm

With the new bankruptcy law contributions made your RRSPs more than one years ago will be exempt from your bankruptcy. There are other changes too but one of them is that contributions made 12 months ago are exempt from bancruptcy.

Roger March 30, 2010 at 3:37 am

Does the fact tha the actual cash value of an RRSP is less than the bookvalue affect how taxable the money would be if cashed in?

Tax Guy April 1, 2010 at 10:38 am

Roger: The concept of the RRSP is that you deduct contributions to the account from your taxable income and add withdrawals to taxable income. Gains and losses inside the RRSP are not taxable and have no tax implications.

Robyn May 2, 2010 at 5:42 am

10 years ago, I moved to australia, I now live here permanently.

I have found out I have a long lost rrsp account with tdwaterhouse. I have sold out all my stocks and would like to transfer the money made (16 000) here to Australia.

I will not be returning to Canada and would like to make use of the money here.

Can you tell me how much I will owe the government? Or can you recommend the best route for me to go down

Thanks

Tax Guy May 2, 2010 at 3:47 pm

Robyn:
TD will probably withhold 25% on a lump sum withdrawal. You may have to claim the cash out in Australia.

bob May 4, 2010 at 1:06 pm

I am in a similar situation as @Robert:

Did you mean to pay off the CC debt, and then rebuild the RRSP’s. You get a little confusing there near the end. It seems a better way to go to be out of debt. I mean you lose that contribution room, but you are also estimating a 7% rate of return, which is pretty hard to guarantee over the next 53 months.
Of course I am ignoring the tax consequences beyond the 30%, but also ignoring the positive consequences of the continued RRSP payments in reducing future tax payments.

Tax Guy May 5, 2010 at 6:02 am

Hello Bob:

The long term rate of return on investment is about 7%. This an opportunity cost, not a guaranteed rate over the next 53 months. If the money were left alone in the RRSP until retirement, a reasonably diversified portfolio of stocks would generate 7%.

Kate July 9, 2010 at 11:12 am

What are the tax implications if I withdraw funds from my rrsp now, but replace them before the end of the year? Can I do this?
As you can see, I have some short-term cash requirements, that will return to me within this year.

Tax Guy July 9, 2010 at 2:25 pm

The tax implications are simple, if you withdraw $5,000 and contribute $5,000 the taxes are neutral. The problems is that the financial institution will have to apply withholding tax. You will have to withdraw $5,882.35 to get $5,000. So you end up with $5,882 included in income and will only contribute $5,000 back. You have $882 taxed as income.

Can you borrow the funds from a family member?

rob February 17, 2011 at 3:54 pm

I thought you said anything over 5000 results in a 20% withholding tax. As bad as my math is 882 is 15% of 5K no?

Tax Guy February 17, 2011 at 4:05 pm

I may have had the non-resident withholding tax of 15% on my mind when I responded. The rate aside, the concept remains the same: You still have to withdraw more than what you need to pay the tax bill.

Gord August 25, 2010 at 3:06 pm

What are the tax implications if I have had no employment income for 2009 and 2010 and I cash in a 50K RRSP. I would use this money to pay down credit card debt of about 35k.

Tax Guy August 25, 2010 at 3:28 pm

The full amount of RRSP withdrawal will be added to your taxable income for the year. The plan provider will withhold 30% and you will end up with $35,000 after the withholding. Depending on how much other taxable income you have, the 30% ,may or may not be enough.

Christine September 9, 2010 at 3:21 pm

I was just on the phone with a Royal Bank Rep and he told me that Quebec is NOT 1/2 of the table.
In fact I have to pay double the rate.
15 to 20%.

Tax Guy September 12, 2010 at 7:55 pm

The table show Federal tax withheld.

Dave November 10, 2010 at 4:31 pm

I want to know what the rules are to cashing in my mutuals . I have gone back to school later in life and was informed by my advisor that if I earned less than $5,000 last year I could withdrawal my funds , but I may have to put it back in 2 1/2 years time . Anyone have any addditional info. I am starting a new employment position where I am required to have a newer vehicle , so I need some othe funds for that reason . The position pays huge and it is flexible hours and a very good company to work for .

Tax Guy November 12, 2010 at 10:43 am

I suspect your advisor is referring to the Life Long Learning Plan (LLP). The plan allows you to withdraw if you attend an approved post secondary education program.

Clare December 5, 2010 at 12:24 pm

I have two RRSP with different institutions. I would like to close out one of them, use some of the money to pay down debt and then put the rest into my other RRSP. Can I do all of this at once?

I appreciate the help, thanks!

Tax Guy December 6, 2010 at 9:12 am

Clare,
You can transfer from one RRSP to another without tax implications. You can withdraw what you need to pay down debt and then consolidate your remaining RRSP accounts.

Be sure you are aware of the income tax implications of the RRSP withdrawal.

Eric Hansen December 19, 2010 at 12:29 pm

I am self employed and do not draw on wages from my business instead I take a dividend at the end of the year. This results in paying $0.00 taxes although my business pays the taxes on the dividend instead of getting a deduction for payroll expenses had I drawn a wage. This is basically a trade off but I save on the Canada Pension because my company does not have to match the amount I would have to pay. My question is should I withdraw some of my RRSP,s now? If I withdraw about $14000.00 it should be tax free.

Tax Guy December 19, 2010 at 6:56 pm

Federally you pay tax after $10,320 assuming only the basinpersonal amount and that you do not receive dividends.

Fred December 22, 2010 at 12:59 pm

This is a very informative blog to which I have a planning question:

I have done very well within my sheltered RRSP and TFSA. To the point I’m looking at 7 figures by the time I go to cash out. I am currently 55 years old.

What is the latest age that I can defer cashing out and, what options are available to marginalize tax burdens.

Thank You

Tax Guy December 22, 2010 at 4:25 pm
Fred December 23, 2010 at 4:29 pm

Appreciate the link. Next question:

I now hear that any contribution to spousal RRSP must come out of my “room”. I cannot top off my limit and contribute further to the spousal.

Is this good information?

Thanks!

Fred December 23, 2010 at 5:40 pm

Found the answer – I’ll try not ask anymore until I’ve given the entire site a thorough read.

Cheers!

Tax Guy December 23, 2010 at 9:17 pm

Yes. It is your contribution room and your deduction.

Percy Lauwaert December 27, 2010 at 8:01 pm

Both my wife and have pensions that are fully indexed up to 6%/ yr. max, combined gross pension of $110,000 +CPP +Investment Income of aprox.$12,000. Currently have $26,638 in our TFSA. Our tax bracket should increase over time.
What is the best way to draw down our RRSP? Have no debt and monies left in our RRSP will be taxed at 50% when if we are both deceased. Please respond in an email as then I will be assured of your answer

Tax Guy December 28, 2010 at 10:53 am

You will probably be better off over the long run to leave the funds in the RRSP and draw them out as a RRIF minimum after age 71. Any RRSP meltdown strategies are high risk and, in my opinion, nor worth the effort.

Maximize your pension splitting options as this will lower your overall tax bill.

Fred January 6, 2011 at 12:45 pm

I have my TFSA holdings in a self directed traded account. I am told that my discount house does not do private placements (PP) and that a PP is deemed an asset transfer.

I am told by fellow investors that full service brokers ARE doing PP’s for clients within TFSA accounts including warrants.

If I were to change to full service broker, are PP’s in fact allowed under TFSA accounts?

Thx

Tax Guy January 6, 2011 at 4:03 pm

@Fred,

It would really depend on whether the underlying investment was a “qualified investment” for the purposes of the TFSA.

The phrase “private placement” speaks to how an investment is brought to market and is not the investment vehicle itself. For example, a public corporation could issue its shares on a designated stock exchange or instead, it could issue them to a single (or group of investors through a private placement). The real question that must be answered is whether the shares or debt or other investment vehicle meets the conditions.

Fred January 6, 2011 at 4:05 pm

yes, this particular one does meet RRSP/TFSA eligiblity

Tax Guy January 6, 2011 at 4:11 pm

I think what you might be referring to is a syndicate offering where the company places its shares with a syndicate of investment dealers who then sell the shares to their own clients.

Most discount brokerage do not participate in this market because they do not have a network of brokers to sell the securities to their clients.

The short answer to your question is that if the investment itself qualifies as TFSA eligible then you can hold it in a self-directed account regardless of what the institution is. However, since you deal at a discount brokerage, you may not be able to participate unless the broker can buy into the syndicate.

If you go to a full serve brokerage firm, you may be able to participate, but if you participate and then pull out immediately, you will probably be charged some transfer out fees. In addition you’ll have to pay their commissions on the placement.

If the placement is simply publically traded securities, you may be better off buying them on the open market through the discount broker.

Fred January 6, 2011 at 5:22 pm

During the course of exchange here I am in process of having a new TFSA account set up with a full service broker.

I’ll be transfering cash out of the discount side via form 2033 to the new account.

The PP purchase is direct from the company together with a group of investors. Due to the volume and market availibilty, it makes sense to participate. The full warrants are a bonus.

Original question was due to information I had rec’d from the discount house that PP’s were considered “asset relocation”. Obviously this is wrong and inaccurate advise. I’ll be taking them up on it.

Thanks again for great info.

wayne h. January 9, 2011 at 1:27 pm

I’M 65 RETIRED with an income of 41,000.per year from cpp and my pension,I have some rrsp’s i want to cash in for my daughters wedding approx.20k what happens of they are locked in from year to year,the avearage interest i make on them is 1.7 % should i cash them in or leave them and borrow the money.I need to know before jan24th the maturity date.Is there a penalty if i go pass that date?

Tax Guy January 10, 2011 at 9:22 am

@Wayne H.,
I have removed your last name as you have disclosed personal information. I would advise that you avoid providing personal details on a public internet site such as this.

I’m not certain I understand what you mean by “locked-In.” Are these in some sort of locked-in GIC or are they in a Locked-In RRSP that had some from a pension plan from a former employer. If these are Locked-In RRSP’s from a pension plan, there is a maximum withdrawal that cannot be exceeded.

If there investment is simply locked-in GIC, then borrowing may cost you more than the lost interest. You will need to calculate the interest lost on the RRSP and the cost of the interest on the loan.

hugh January 26, 2011 at 1:26 pm

Hi Tax Guy,

Hopefully you are still checking this article. My wife and I just purchased our first home and want to talke advantage of the first time buys clause that allows you to take out 25K per person. Unfortualte we have not evenly distributed our RRSP and most was in a spousal that I set up for my wife. The contribution are from me and I wonder if there is anyway to transfer the spousal contribution to my name so I can claim them. Note. The RRSP has not been claim on any tax return.

Thanks Hugh

Tax Guy January 27, 2011 at 10:02 am

Only the annuitant can withdraw from their RRSP and only non-spousal accounts can be rolled into a spousal plan (not the other way).

Evelyn February 2, 2011 at 9:14 pm

Hi Tax Guy,

My husband had two RRSP’s, one with his company and one with our bank. We ended up needing some money to purchase a new furnace this past year and pulled out some money from one of our RRSP’s. I don’t remember exact amounts but we withdrew the first $5000 and paid tax on it. Then withdrew another amount and paid tax on that. Then we decided just to close the RRSP’s altogether and withdrew the final amount in our RRSP’s (I think it was somewhere around $1000). Silly decision? I think so. There was just less than $10,000 in the RRSP’s when we started withdrawing. I’m just wondering what kind of income tax we should expect to owe. Is this going to be a major amount of money we are looking at here?

Just a little nervous about the upcoming tax season.

Thanks in advance,

Evelyn

Tax Guy February 3, 2011 at 4:43 pm

Take the $10,000 ad multiply by your marginal tax rate (use walterharder.ca to estimate your MTR using your taxable income BEFORE the RRSP withdrawals). Then deduct the withholding tax on the withdrawals.

This will give you an estimate of the tax difference owing.

Mike February 17, 2011 at 10:50 am

In today’s world with TFSA’s an RRSP should be used as a tax differral plan and that’s it. Put money in when your earning great income take it out when your not, that might be during periods of being laid off might be all the way until retirement. The main thought is to put it when you would be paying 30+cents on the dollar in taxes and taking it out when your tax rate is way lower, this way you are pocketing the difference in tax you would have paid.

Tax Guy February 17, 2011 at 4:22 pm

Nicely put

dj February 18, 2011 at 10:25 am

Well said Mike,but i’m almost sure advisers will not recomend this,just as they don’t want you to put your home loan in there too.

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