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Withdraw From RRSP & Pay Mortgage

Question: I am looking to make an early withdraw of $20,000 from RRSP account to pay my mortgage off but I am also planning to pay the exact amount back into RRSP account in the next few years. What are the implications?

I Live in Ontario and my annual Income is $50,000. My RRSP earns about 4% and my mortgage rate is also about 4%.

Your RRSP vs. Mortgage Options

Your overall financial planning objective is to increase your net worth (what you own less what you owe). It is important to consider other options than cashing out your the investment portfolio in your RRSP.

Three Options

  1. Do nothing
  2. Withdraw from your RRSP now and pay down the mortgage. Then pay back the amount withdrawn from your RRSP over 5 years ($4,000 per year).
  3. Make $4,000 per year principal payments to your mortgage and forego the additional RRSP contribution.

Other Assumptions

Let’s also include some other assumptions for illustrative purposes:

(Note if your average return on your RRSP is 4% over the last several years, you should look at finding an investment advisor. Ideally, you should be in the 6% to 8% range if you are more than 10 years from retirement).

1. Do Nothing

In 5 years,

Your net worth (what you won less what you owe) increases by $143,600.

Your annual tax bill, assuming only the basic tax personal credit and an RRSP contribution of $4,000, is $8,595.

2. Withdraw From The RRSP And Pay Down The Mortgage

If you withdraw $20,000 from your RRSP now, you must add that amount to your taxable income in the current year. Following the withdrawal, your taxable income increases to $70,000 and your total tax bill for the year would be $16,191.

As a result, you will really only have $13,650 available to put against your mortgage and will pay $6,350 of extra income tax. All this before you have even put any thing against your mortgage.

Putting the $13,650 against the mortgage and using an additional $4,000 per year to contribute to your RRSP, in 5 years:

Your net worth would decrease to $136,000.

This strategy actually costs you $7,600 in net worth and you have paid $6,350 of additional income tax.

3. Annual Principal Payments of $4,000

Your taxable income increases because you do not make any additional contributions to an RRSP. Your annual tax bill will be $1,250 per year more. In 5 years:

Net worth would increase to $144,000.

The difference between option 1 and option 3 is negligible and really you should be indifferent between the two options.

Another Option – RRSP Mortgage

Rather than cash out your RRSP and pay down your mortgage, you can use your RRSP assets and then borrow from your RRSP using an RRSP mortgage. This strategy is rather conservative in terms of the investments for an RRSP, it might fit your needs.

Here is how it works:

In your case you will now have 2 mortgages:

In 5 years:

Your net worth is $166,700.

Note that I have not included the RRSP mortgage as a debt. The RRSP mortgage (a liability) is offset by a mortgage note (an asset).

Also, since you are re-paying a debt inside your RRSP with interest, you are actually contributing an extra $22,000 to your RRSP without affecting your contribution room.

Finally

taxplRRSP mortgages are suitable for some and not suitable for others. Do your research. Here is some additional information and articles on the web related to RRSP mortgages:

Recommended Reading

Tax Planning for You and Your Family 2009 – chapters.indigo.ca [2]

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