By Douglas Hoyes
Special to the Financial Independence Hub
You may find yourself with both debt and accumulated RRSP savings. This often happens when people are enrolled in automatic savings programs at work or when debt accumulates due to illness or time off work late in life.
You may wonder if it makes financial sense to cash in your RRSP to pay off your debt. Every situation is different, so there is no one correct answer that will apply in every case, but there are two main factors to consider:
- Your expected return versus the cost of debt; and
- The size and type of debt you carry.
Perhaps the most important factor will be the return you expect to receive on your RRSP versus the interest you are paying on your debt. The higher the interest you pay on your debt, the more likely it is that you will want to consider using your RRSP to pay off your debt. For example, if you owe $10,000 on credit cards with a 20% interest rate, and you are earning 1% in a GIC in your RRSP, cashing in your RRSP to pay off the debt, and saving 20% interest, may make sense.
Taxes may complicate calculations
Of course, the math is not quite that simple because taxes must also be considered. If your marginal tax rate is 50%, you need to cash out $20,000 from your RRSP to generate the $10,000 required to pay off your debt.
That leads us to the next consideration. Will withdrawing funds from your RRSP solve your debt problem and will you have time to replace those savings before retirement? $10,000 in debt may appear to be a manageable amount, but what if you have $70,000 in unsecured debt (which happens to be the amount owed by seniors when they became insolvent in our recent Joe Debtor study)?
In many cases, individuals can be insolvent even while having savings inside their RRSP. If your only significant asset is your RRSP, and if you don’t have the income to service your debt, another option to consider may be a consumer proposal or personal bankruptcy.
What if you go bankrupt?
But if you go bankrupt, don’t you lose your RRSP?
In most cases, no.
Under federal law, your RRSP is exempt from seizure in a bankruptcy except for the amount you contributed in the last year. You don’t lose your pension in a bankruptcy, so to ensure equal treatment of pensions and RRSPs the government decided that you can keep your RRSP if you go bankrupt, with the exception of your contributions over the last twelve months (the 12-month rule is designed to prevent debtors from “filling up” their RRSP on the eve of bankruptcy as a way to defeat creditors).
So, if you have significant debts, cashing in your RRSP may not be the best strategy, particularly if you are close to or in retirement. A consumer proposal or bankruptcy may be a better option, but as there are many other factors to consider, consulting an expert advisor is imperative before you decide how best to deal with excessive debt.
Douglas Hoyes, BA, CA, CPA, CBV, CIRP is a licensed bankruptcy trustee and the co-founder of Hoyes, Michalos & Associates Inc., one of Canada’s largest independent personal insolvency firms.