Using RRSP to Pay Off Debt

Paying Off Debt By Cashing In Your RRSP

In the realm of personal finance, one discourse often outshines others – the potential benefit or detriment of using RRSP to pay off debt. This guide aims to equip you with the knowledge to make an informed decision regarding this crucial aspect.

Understanding RRSP

A Registered Retirement Savings Plan (RRSP) is a financial tool primarily designed to foster retirement savings for Canadians. Its unique feature is allowing contributions to grow tax-free until withdrawal, which is typically during retirement.

Mechanics of RRSP

RRSP accepts pre-tax income from both employees and self-employed individuals. The tax advantage comes into play when you retire and begin to withdraw the funds. Since your income level is likely lower at this stage, the tax rate applied to the withdrawn amount would be less than if you cashed out the funds at a younger age.

However, early withdrawal could attract up to 30% tax depending on your province. Some exceptions exist, but they come with stringent repayment terms.

The Debate: Using RRSP to Pay Off Debt

The idea of using RRSP to pay off debt is a contentious topic due to the potential implications for your financial future. Here are some reasons why it may not be the best strategy:

Impact on Retirement Plans

Draining your RRSP to clear debt could jeopardize your retirement plans. Fewer years left to contribute to your pension could result in a less comfortable retirement.

Loss of Potential Interest

Early withdrawal of RRSP funds means you forfeit the compound interest that could have grown your retirement fund.

Income Tax Liabilities

The funds in your RRSP are deductible from your annual income and therefore not taxable as long as they remain in the RRSP. Cashing out your RRSP makes the withdrawn amount taxable.

Withholding Tax

Early withdrawal of RRSP funds for any purpose other than buying a first home or retirement attracts a withholding tax, decreasing the amount available for debt repayment.

Alternatives to Using RRSP for Debt Repayment

If you’re struggling with overwhelming debt, consider consulting a Licensed Insolvency Trustee. As the only professionals in Canada legally able to file all forms of debt relief, they can provide reliable advice tailored to your financial situation.

Bankruptcy and Consumer Proposal

Bankruptcy offers a fresh financial start by eliminating unsecured debts without affecting long-term investments. A consumer proposal, another popular choice, involves proposing an affordable repayment amount to your creditors. This method can reduce debt by up to 80% while allowing you to retain your assets.

Both these debt relief forms also aid in rebuilding your credit score, opening up future financial opportunities.

Asset Liquidation to Clear Debts

Another possible strategy includes selling assets to clear debts. This could involve parting with valuables, an old car, antiques, jewellery, or investment accounts other than RRSPs.

Ideal Use of RRSP

While RRSP is intended for funding retirement, certain circumstances may necessitate early withdrawal.

Home Buyers’ Plan

Under the Home Buyers’ Plan, you can withdraw up to $35,000 from your RRSP for a down payment on your first home. This withdrawal must be repaid within fifteen years, starting two years after the withdrawal.

Lifelong Learning Plan

The Lifelong Learning Plan allows withdrawal of up to $10,000 per year (to a total of $20,000) to fund education. This amount must be repaid within ten years.

Conclusion

The decision to use RRSP to pay off debt should be made after careful consideration of your financial circumstances. Consulting with experienced Licensed Insolvency Trustees can provide critical insights and recommendations.

A well-planned approach to managing debt can pave the way for a secure financial future. Remember that using RRSP to pay off debt is not always the best solution, and other alternatives may offer more promising long-term benefits.

Find Your Personal Debt Relief Solution

Licensed Insolvency Trustees are here to help. Get a free assessment of your options.

Discuss options to get out of debt with a trained & licensed debt relief professional.