Should you pay off your debts with your RRSPs?

Should you pay off your debts with your RRSPs?

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When you are in debt and looking for solutions, you may be tempted to withdraw your RRSPs to pay off your creditors. Watch out, as this could contribute to sinking you further!

Before going to consult an insolvency practitioner, consumers generally do everything in their power to get out of a debt situation. Borrowing money from relatives, fast loans with high interest rates, selling goods, etc. And when they have managed to save for their retirement, many also decide to withdraw their RRSPs to deal with the most urgent and hope to solve their debt problem. But not only is this just a temporary fix, it also risks making the situation worse than it already was. 

Loser on all counts

It is not uncommon for people who come to consult Véronique Lalonde, a licensed insolvency trustee at Raymond Chabot, to have disbursed their RRSPs before realizing the facts and making an appointment with an insolvency professional. “It may help temporarily, but it does not solve the problem at the source. In addition, the disbursement creates an additional tax debt,” she warns. There will indeed be both short-term and longer-term repercussions.

“First, the financial institution will make a withholding tax. Depending on the amount withdrawn, this can represent 10 to 30% of the amount. In addition, this withdrawal from your RRSPs also adds to your annual income, which could increase your tax rate,” she says.

For example, let's say you earn $40,000 a year and withdraw $15,000 from your RRSPs. In this case, the bank will withhold 20% of this amount, but you will still have to declare $55,000 of annual income, which will increase your tax rate to 37%. “You could therefore find yourself with an additional tax debt to pay to the tax authorities, which will increase your debt even more”, mentions the syndic.

Added to this is also the potential loss allowances, credits and deductions on your next tax return, due to the increase in your income. 

Two disbursement situations

< p>Véronique Lalonde reminds us that an RRSP should only be disbursed in two situations: the Home Buyers' Plan (HBP) and the Lifelong Education Incentive Plan (REEP). With the RAP, you can withdraw up to $35,000 from your RRSPs without being penalized for tax purposes. You then have 15 years to repay this amount in your RRSP.

Under the LLP, it is possible to withdraw up to $10,000 per year up to a total amount of $20,000 within five years from the first withdrawal, in order to pay tuition fees or those of her husband. You then have a maximum of 10 years to repay them. 

Remember that any withdrawal will result in the permanent loss of your RRSP contribution rights. “In addition, the hard-earned savings for retirement will be lost forever,” laments Véronique Lalonde. It also reminds that the RRSP is unseizable in the event of bankruptcy or consumer proposal, with the exception of the contributions of the last 12 months. 

ADVICE:

  • The amounts you have managed to contribute to your RRSPs should be set aside for retirement to ensure a more comfortable standard of living. In addition, this savings tool makes it possible to defer taxes, but the tax authorities will take their part as soon as you disburse them, whether you are already retired or not. 
  • If you have other types of savings, such as a TFSA or a registered GIC, dip into this nest egg instead of your RRSPs. It's not the ideal solution, but it's a lesser evil. 
  • You have contributed to your spouse's RRSP and he makes a withdrawal within three years according to this contribution? Be careful, because it is you who will receive the tax invoice.

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