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by Janet Doyle
More Canadians are withdrawing from their RRSP’s to pay down their debts, but could they be saving more money?
40% of respondents polled by the Bank of Montreal (BMO) said they have made a withdrawal from their RRSP; the average withdrawal in 2017 was $20,952, almost 22 per cent more than the average amount of $17,213 taken out in 2016.
Why are Canadians withdrawing from their RRSP’s? The survey showed that Canadians need the money:
- To help pay for living expenses (23%).
- For emergencies (21%).
- To pay off debt (20%).
There are a lot of things to consider when thinking about taking from your RRSP savings, but ultimately it comes down to a number of calculations to ensure you know the exact cost of withdrawal and how it will affect your overall financial health in the long term.
1. Deductions
Once you deduct money from your RRSP, the financial institution will take off an amount to pay withdrawal taxes between 21-31% (depending on the amount). With the exception of Quebec*, the rates for residents are:
- 10% for less than $5,000
- 20% for $5,000-15,000
- 30% for anything $15,000+
*Quebec residents pay half the interest rate but are charged provincial tax. More information available at Revenu Quebec. Non-residents of Canada pay 25% unless they live in a specific country that is subject to a lower rate.
Sun Life Financial has a helpful calculator that can show you how changing how much you put in your registered retirement savings plan (RRSP) can affect your retirement savings and show you what would happen if you took money out before you retire.
2. Taxable Income
The amount you withdraw from your RRSP will be added to your taxable income and could potentially move you into the next bracket, meaning you will have to pay more in income tax. If you must withdraw from an RRSP, it’s ideal to do so during a taxable year where you have reduced, little or no income (Such as a job loss), to avoid paying additional taxes that you would at a higher income level.
3. Contribution Room
Unlike programs for first time home buyers or students that allow you to “borrow” from your RRSP, you are not able to replace it. The contribution room that you were building will be lost forever and you won’t be able to add any additional funds beyond your annual limit.
4. Compounding Interest
The greater the amount in your RRSP account, the more money you’ll have when you go to withdraw it at retirement. As interest accumulates on your investment your balance will grow and you’ll make even more interest off the total amount. When you withdraw from your RRSP’s you’ll lose the growth potential of that amount, setting you back by reducing the amount of interest you earn each year.
5. Retirement
When considering all the factors that affect the amount you will receive after taxes as well the effect it will have on your retirement income and your quality of life down the road, it can be hard to determine the best option for your future. Once you are in your golden years your ability to earn income will be diminished, so it’s better to have more money in your retirement savings now and allow it to work for you by growing with compounding interest.
6. Alternatives
All of these factors beg the question – what are the alternatives to pay back debt?
- TFSA – Withdrawing from a TFSA is a more favourable option and has less of an impact on both your short- and long-term financial future. Unlike an RRSP, a TFSA account allows you to recontribute and you don’t lose the contribution room.
- Consolidation Loan – Speak to your bank about a consolidation loan that would allow you to pay your debt back at an affordable interest rate. However, many people find that they do not qualify because they have applied too late and their credit rating has diminished.
- Sell Assets – If you have any assets of value such as a car, cottage, or recreational toy (like a boat or motorbike) it most likely makes more financial sense to sell them for cash rather than pay the fees to withdraw from your RRSP.
- Re-Mortgaging Your Home – Your mortgage lender may be able to offer you financing at a lower rate through a home equity line of credit or Short Term Loans – Installment and installment loans are not recommended due to their high interest rates and fees; read more on our blog How Short Term Loans Become Long Term Debt
- Consumer Proposal – A formal, legally binding settlement that will allow you to keep any retirement savings contributions that are over one year old. This means you could eliminate your debt completely, pay back a portion of what you own and start fresh while still keeping the majority of your savings for retirement. Calculate your savings with our Debt Reduction Calculator
- Bankruptcy – If you are unable to afford a consumer proposal, bankruptcy can clear you of your debts so you can make a fresh financial start. Under Bankruptcy protection you get to keep RRSP contributions made over 12 months ago, retaining your retirement savings and allowing you to start over.
A Licensed Insolvency Trustee can help you examine all of your options. Our debt management professionals have helped thousands of people manage their excessive debt, repair their credit scores, and achieve a fresh financial start to take them into their golden years. Contact us to book a free consultation in Eastern Ontario and Quebec: [email protected] or call 1-800-517-9926.