When you’re struggling with debt problems, every payment is difficult and every dollar counts, it can be tempting to grab RRSPs to pay your debts. But is it really a good idea?
Before withdrawing funds from your RRSPs to pay off your debts, you should consider the following:
Part of your disbursement will be withheld
As much as it is advantageous to contribute money to an RRSP, it is expensive to withdraw. Indeed, part of the amount withdrawn will be withheld directly by the financial institution.
- For a withdrawal of less than $ 5,000, 21% is withholding
- For a withdrawal between $ 5,000 and $ 15,000, 26% is withheld
- For a withdrawal of more than $ 15,000, 31% is withheld
For example, if you need $ 10,000 to pay the credit card balance, you will actually have to withdraw more than $ 13,500 from your RRSPs to get the required $ 10,000. And this does not include the tax you will have to pay on the money withdrawn (this money will be added to your income for the purposes of calculating your taxes payable).
You may have to pay exit fees on your investments
If the money in your RRSP is invested in investments such as mutual funds, you may have to pay fees to liquidate these investments.
The reason is that many investments come with exit fees , that is, a percentage of fees to pay out of funds for a number of years. The percentage typically decreases over time, which means it is more expensive to exit a young investment than a multi-year investment.
Amounts withdrawn will be added to your taxable income
For tax purposes, amounts withdrawn from your RRSPs are counted as income, just like employment income, for example. The tax you pay may be even more expensive than expected if the RRSP withdrawal moves you to a higher tax bracket.
For example, if your basic income is $ 42,000 a year and you withdraw $ 5,000 from your RRSPs, your taxable income will be $ 47,000. This increase in your “income” will move you from a marginal tax rate of 31% to 37%. In the end, this withdrawal of $ 5,000 will cost you about $ 1,700 in additional tax ( pay attention to tax debts ).
Do you mortgage your retirement to pay your debts?
The primary goal of contributing to RRSPs is to build a retirement fund. You will not be able to work all your life and there will come a day when you will need to disburse your RRSPs to meet your needs. Fewer and fewer people are receiving a pension fund from their employer, so the RRSP has become indispensable for a majority of Quebecers who are retired.
If you draw in your RRSPs repeatedly, you are only postponing the problem and there may be fewer solutions available to you at this time. It is certainly more difficult to qualify for solutions such as debt consolidation when our income is lower (as is the case in retirement).
Your RRSPs are not seizable in bankruptcy
Although you probably have not made it to the point of declaring bankruptcy, it is reassuring to know that your RRSPs would not be seizable in this event (with the exception of your contributions in the 12 months preceding the bankruptcy).
This means that if your financial situation becomes even more difficult and you have to turn to the Bankruptcy and Insolvency Act , your creditors would not be allowed to touch your RRSPs. The purpose of the Act is to protect your savings for your retirement.
When is it a good time to withdraw RRSPs before retirement?
While it is generally a bad idea to withdraw RRSPs before retirement, there are some exceptions to the rule:
- For RAP-er. The Home Buyers’ Plan (HBP) allows a person who has not been a homeowner for the past 5 years to withdraw up to $ 25,000 from their RRSPs without this amount being taxable. However, the withdrawn amount must be returned to RRSPs within 15 years of withdrawal.
- To go back to school The Lifelong Learning Plan (LLP) allows a person to withdraw up to $ 20,000 from their RRSPs for up to 4 years to return to school.
- To stabilize his income temporarily. If you are unemployed, on extended leave, or your business has a bad year, you could withdraw money from your RRSPs to make up for the lack of income. In this situation, since your income is low, the tax rate on your RRSP withdrawals will be very low and you will have very little tax to pay.
What are the alternatives to settle his debts?
Before you touch your RRSPs (or even if you have already done so), we strongly recommend that you consult (without fees) one of our financial reorganization advisers in order to take stock of your situation and to present to you the solutions that are available to you.