Should I Withdraw My RSPs to Pay Down Debt?
On occasion when we are talking with people we find out that, before meeting with us, they arranged to cash out all or part of their retirement savings plan (RSP) and use the proceeds towards their debt. However, it was not enough and they are still in financial difficulties. Was it the right thing to do?
As with so many financial matters the answer is: it depends. In this article we will explore when and why a rsp redemption may or may not be appropriate. Hopefully, it will help you answer the question – Should I withdraw my RSPs to pay debt?
How Much Debt Do You Owe?
We think this is the first step in making any decision regarding paying down your debt. You need to know for sure how much you owe. The easiest way to do this is to make a good old fashion list.
Your creditors are good at finding you so if you take the time to go through your regular mail and email there should be some solid info there on how much and who you owe.
If you are unsure, there is nothing wrong with giving them a call or email to find out about the current balance. Knowing this information is important. If the amount of debt is a lot more than the amount of RSP you have available then it’s probably not a good idea to cash out any of your retirement savings plan.
On the other hand, if the amount of debt is relatively small, and you have plenty of RSP funds, then cashing out a small amount could be a good asset liquidation strategy to get out of debt.
*Don’t forget about possible tax consequences that might arise if you were to cash out any RRSP”s to pay your bills.
Will You Need a RSP Pension to Retire?
As we go through the working portion of our lives, the Federal Government allows us to make RSP contributions in order to build up savings for retirement. For those of us who do not have a defined benefit pension or defined contribution pension plan, retirement savings plans are an important part of future financial security.
Once you stop working, if you don’t have a pension, you will likely be using some of the following to fund your retirement:
- Canada Pension Plan
- Old Age Security
- Guaranteed Income Supplement
- Tax Free Savings Account
- Retirement Savings Plan, sometimes called a Registered Retirement Savings Plan
The goal is to make the RSP contributions while you are working and let the balance grow over time. Then, when you stop working, it will be there to help with expenses.
By withdrawing what you have contributed now, you don’t give it the chance to grow and obviously it won’t be there when you retire. Ideally, you want to contribute to it steadily and watch it grow tax free over your working career.
RSP vs RRSP
These two acronyms are often used to refer to the same thing. An RRSP is technically the phrase that is applicable to contributions that qualify for a tax deduction during the year it is made. Subsequently, any withdrawal is included in your income.
The phrase RSP could be used to refer to any type of saving for retirement.
When most people use the phrase RSP they are referring to a RRSP and just dropping one R. For the discussion below, we are referring to a RRSP.
Tax Consequences of RRSP Liquidation
If you decide to go ahead and withdraw funds from your RRSP there are tax consequences. Your financial institution will issue a T4RSP that you will have to include on your personal income tax return for the year it is withdrawn.
This will increase your income and may result in creating an unexpected income tax debt. Typically, there is only a small amount of income tax withheld on the redemption. As a result, when the RRSP income is combined with your other income for the year, there has not been enough income tax withheld.
This needs to be factored in when making a decision to withdraw RRSP as you will not be receiving as much as you think.
There are other possible consequences as a result of your income going up on your tax return such as:
- Reduced Canada Child Benefit payments
- Reduced GST quarterly credits
- Reduced Guaranteed Income Supplements
- You may no longer qualify for SAFER for rental assistance
Exempt Assets in Canada
At one point in the past, RRSP funds were fair game for your creditors. They could force you to withdraw them. On the other hand, a person with a work pension did not have to worry about losing it to their personal creditors. The Federal Government recognized that was not fair and changed the law to make a RRSP Bankruptcy exempt.
This means, for the most part, you won’t lose your RRSP if you need Bankruptcy protection or file a Consumer Proposal.
There is a safeguard in order to prevent that law from being abused. That safeguard is any money that was contributed to a RRSP in the twelve months prior to filing for Bankruptcy protection or filing a Consumer Proposal is not exempt from your creditors.
This prevents a person from stuffing all of their assets into a RRSP and then getting protection from their creditors shortly thereafter.
Debt Relief Options
Before making the decision to withdraw RSP/RRSP money and use it to pay down debt, we think it is important that you understand the consequences of that withdrawal and also learn what other options might be available.
Other debt consolidation options could be:
- Getting a consolidation loan from your bank or credit union
- Filing a Consumer Proposal
- Filing for Bankruptcy protection
As Licensed Insolvency Trustees, we are the only ones in Canada who can file a Consumer Proposal or Bankruptcy on your behalf. Before doing so, as an independent office, we will take a lot of time with you to explore what pathway would best fit your circumstances. If you could get relief from your debt and keep all of your RSP/RRSP your financial future will be much brighter.
Contact us – we are here to help. Call us to set up a free initial appointment.
Bankruptcy During Covid-19 Podcast
In the podcast below, Derek Chase explains if it’s a good idea to withdraw your RRSPs to pay down your debt. Grab a cup of coffee and listen to this informative conversation.