Should you withdraw from RRSPs to pay debt?

Should you withdraw from RRSPs to pay debt?
2021 / 11 / 05

If you are carrying debt outside of a mortgage or vehicle loan, you might be considering a withdrawal from RRSPs to pay your other debt.

RRSPs are intended to provide tax-sheltered savings for retirement.  Considering many Canadians do not have pension plans through their employer, the decision to cash RRSPs to pay debt should not be taken lightly.  If you were retiring at age 65 in 2021, the maximum monthly amount you could expect from CPP is $1,203.75, however, the average CPP benefit being paid in 2021 is only $619.68 per month.  How long you work for, whether you draw CPP before age 65 and whether you made maximum CPP contributions throughout your career will determine how much CPP you qualify for.  Besides CPP, upon reaching age 65, you may also qualify for Old Age Security (OAS), however it pays a maximum benefit of $618.45 per month, as of 2021.  Some might qualify for additional benefits through the Guaranteed Income Supplement (GIS) program; however, government retirement benefits alone were never intended to cover 100% of your living expenses during retirement.  If you begin retirement with a mortgage and other debt to service, relying on government retirement benefits alone will likely not be sustainable so having some form of personal retirement savings is imperative; especially if you want to remain in your own home as long as you can.

Before withdrawing funds from an RRSP to pay debt, you must consider your marginal tax rate as RRSP income from withdrawals is taxable.  To illustrate, lets assume you earn $50,000 per year, gross before deductions, reside in New Brunswick and owe $25,000 on credit card and other debt that you just cannot seem to quickly pay down.  The marginal tax rate for someone earning $44,887 — $50,197 gross, is 29.82%.   For gross income of $50,198 — $89,775, the marginal rate increases to 35.32%.  Therefore, if you already earn $50,000 per year, gross, a withdrawal from your RRSP will put you in the next bracket with a marginal rate of 35.32%.  As a result, if you intend to pay off $25,000 in debt, you will need to withdraw approximately $39,000 from your RRSP to net $25,000 after taxes to pay off your debt.  Even if you cannot afford future RRSP contributions and assuming you are 40 years-old, leaving $39,000 in your RRSP until age 65 could amount to approximately $286,000, if you earned an average return on investment of 8%; a return of 7% could still net you $223,000 after 25 years.

Before withdrawing funds from RRSPs to pay debt, it would be a great idea to explore other options for debt relief.  In a Bankruptcy or a Consumer Proposal, RRSPs are protected from creditors and therefore are yours to keep, however, these options might only make sense if you had no other options to consolidate debt at a reasonable rate of interest — provided you can afford the consolidation loan payments.

If you are looking for advice or a second opinion about your debt, it does not cost anything to talk about your options.  At Jaime Johnson & Associates, you will always deal with Jaime, a Licensed Insolvency Trustee.  Together, we will review and discuss all options for debt relief until you are confident you are making an informed decision.