Should I Withdraw from RRSP’s to Pay Credit Card Debt?

1. 1. The Financial Blogger

   I would rather consolidate credit cards with a personal loan with a 8% interest.

   The power of compounding interest applies only on investment and not on debt. Therefore, if you are able to decrease your interest charges via a consolidation loan or a mortgage, you will be better off keeping your RRSP.

   Aug 26th, 2008 @ 8:25 am

2. 2. Traciatim

   When I first set up my RRSP through work it was with the plan of using it to buy a house so it was being saved to withdraw (including the 100% match of 6% of my salary).

   The first time we applied for a mortgage we couldn’t get one, so my spouse decided to go back to school. While her income was gone I withdrew funds under the LLP to pay off our 8K car loan at 14%.

   After this we kept saving in the RRSP and about a year later withdrew under the HBP to buy a home, draining our RRSP down to 0.

   What’s kind of funny, is we purchased our home just before the TSX started falling apart, and now I’m dollar costing back in to it as things keep sliding and remaining stagnant. Real estate in my city has supposedly increased in the same period about 17% YOY (Average sale price, CREA, my purchase month). So it looks on paper like things are working out for me so far.

   Hopefully the company continues to match my contributions well in to the future as 12% of my salary will make a secure retirement. Add to this the coming TFSA and then later a taxable investment account and we should retire with a paid off house, an RRSP/RRIF, a good sized TFSA, and some great dividend income . . . ahhh, I can taste the relaxation now.

   Aug 26th, 2008 @ 8:43 am

3. 3. MoneyGrubbingLawyer

   FT, I have never used RRSP funds to pay down debt (although we did withdraw under the HBP), although I can see how it would make sense for some people.

   I would think that there is also a psychological benefit to eliminating debt. Even if it actually costs you money in the long run, for some people the relief of being debt-free may be worth it.

   I would also assume (hope?) that someone withdrawing their RRSPs to pay off debt would also be smart enough to then take the money they would have spent on debt repayment and divert it back in to RRSPs, changing your calculations a little, although not enough to make a significant difference.

   Aug 26th, 2008 @ 10:28 am

4. 4. FrugalTrader

   FB, good call, i’m also a believer in consolidating credit card debt before initiating aggressive pay down.

   Traciatim, 17% annual gain? You must be from either Sask, or NL. :) Congrats on taking control of your finances!

   MGL, ah yes, yet another psychological component of debt. I agree, for some, debt is a very emotional burden and getting rid of it may “feel” better. In my opinion though, people have to look past that immediate gratification and look a few steps ahead to see what’s best.

   Aug 26th, 2008 @ 11:00 am

5. 5. Gates VP

   Hey FT;

   I have in fact done this. I had just split up with GF at the time in December and had to move out my own. Oddly, when I crunched the numbers, I wasn’t living “beyond” my mean, just right at them. From month to month my net worth was basically hovering at zero. Here I was throwing 10% into the low-earning RRSP but barely reducing the Credit Card debt, so it just didn’t make a lot of sense.

   I’ll quote MoneyGrubbingLawyer
   I would think that there is also a psychological benefit to eliminating debt. and I would also assume (hope?) that someone withdrawing their RRSPs to pay off debt would also be smart enough to then take the money they would have spent on debt repayment and divert it back in to RRSPs

   Once I broke even, I ended up depositing money back into the RRSP and still ended up “positive” on total contributions for the year.

   Does it feel great? Not really, but how great does it feel making 30k / year and having 3.3k in one “account” and negative 3k in the other? And then knowing that the negative account is growing faster? At some point, you just call it a wash before it gets any worse.

   Yes there are better options: lower interest line of credit, consolidation loans (but not on 3k), but there’s also the psychological aspect of not owing any more money.

   On the other hand, you still have to “Know Thyself”. If you pay off the debt without making any life change (i.e.: using the RRSP) you may just end up in the same situation because you haven’t made the requisite changes.

   Aug 26th, 2008 @ 11:02 am

6. 6. Patrick

   Your tables are comparing tax-sheltered amounts against taxed amounts. Sooner or later, you’ll have to cash in those RRSPs. You should factor those taxes into the equations and see what happens.

   Aug 26th, 2008 @ 11:38 am

7. 7. FrugalTrader

   Patrick, would you care to elaborate? My calculations above include after tax amounts when withdrawn from an RRSP. On a separate note, the goal when withdrawing from RRSP’s is to withdraw during lower taxation years (hopefully during retirement).

   Aug 26th, 2008 @ 11:48 am

8. 8. nobleea

   If you have two balances, one negative and one positive, might as well just wipe them out as Gates said.

   As long as the credit card debt was a one time thing from schooling or a medical emergency or similar. If it’s just consumer debt, then forget about it, because it’s just going to happen again.

   Aug 26th, 2008 @ 11:50 am

9. 9. SM

   Thanks for this post! I am currently considering doing this very thing. I’m currently on maternity leave and will be for almost the full calendar year, making my income pretty low. We’ve managed to incur about $9K worth of debt on our line of credit – something that makes me very nervous. It will be hard to make any sort of headway on this when I do go back to work as we will have very high daycare costs ($2,600/month). Still not sure, but I do know that we really should try to leave our RRSP’s alone – something easy to forget.

   Aug 26th, 2008 @ 12:00 pm

10. 10. Chuck

    I’ve withdrawn under both HBP and LLP, but never to pay down debt.

    What I have done on occasion is turn off my pre-authorized contributions and used the extra cash flow to attack debt. With a spouse who works at a bank, we also have access to better interest rates.

    Also if you do a withdrawl from your RRSP other than HBP or LLP you lose that contribution room forever. TSFAs are going to let people do this kind of paydown much easier.

    Though I’d argue the first step is to understand why the credit card debt grew out of control and how to get it back in line otherwise you may be in the same predicament two years down the road.

    Aug 26th, 2008 @ 12:02 pm

11. 11. Patrick

    @FT: Take, for example, the 15-year column from your second example. You have computed “RRSP Gain on $9,333″ as $10,070.00, and Credit Card Interest as $6,874.21. Your conclusion is “do not withdraw”, presumably because the “RRSP Gain” is higher than the interest.

    The trouble is, this “RRSP Gain” number reflects the dollar value of that money only as long as it remains in the RRSP. You can’t spend that money, so that’s not the RRSP’s real value. To spend it, you’d have to cash it in and pay tax on it.

    I agree that the taxes would not be 40%, but they would also not be zero, and they should be factored in before you can reach a conclusion.

    If the RRSP is your only retirement income, then the taxes will be quite low. However, that never happens because we all have CPP. The average tax rate on RRSP savings will indeed be lower than your current marginal rate, and even lower than your marginal rate at retirement, but it will be higher than your average rate at retirement.

    If it’s over 31.7%, which is entirely possible, then you’re better off withdrawing the RRSP to pay off the credit card.

    Aug 26th, 2008 @ 12:06 pm

12. 12. Charles in Vancouver

    Chuck, my thoughts exactly – keep the existing RRSP but stop (or throttle) contributions until debt is paid off. And consolidation to a lower rate of course.

    Also an additional thought: If you have assets in your RRSP you’d rather withdraw (e.g. a maturing bond or GIC, cash left over from distributions), and assets in your non-registered account you don’t want to sell, you can ask your broker to do a “swap” of similar amounts. There may be tax consequences depending on the ACB of the non-registered asset but this could help keep your things in balance.

    Aug 26th, 2008 @ 12:20 pm

13. 13. FrugalTrader

    Patrick, ah yes, I know what you’re saying now. You are right, I should have accounted for that in my calculations somehow, but it’s a difficult assumption to make as to what tax bracket they would be in during retirement. Let me look into this further.

    Aug 26th, 2008 @ 12:29 pm

14. 14. Returns Reaper

    FT,

    One other thought to consider is that after the RRSP was withdrawn and CC debt repaid, the money that was being used to service the CC debt could now be added as a cash flow back into the RRSP (assuming you have the contribution room). So you could end up contributing ($7k * 12%) / (1 – MTR) = $1400 per year (MTR=40%). This assumes a short term loan at RRSP contribution time (to contribute more than your savings assuming a tax rebate), but it should be negligible. Does that make sense?

    One other factor to consider before doing something like this is that the amount withdrawn is contribution room lost forever. So if you anticipate running out of contribution room in the long term, this should be considered as well.

    Aug 26th, 2008 @ 1:08 pm

15. 15. Dividend Growth Investor

    As a general rule of thumb I wouldn’t withdraw retirement funds to pay off credit card balances or just spend them. For most people who were used to using their houses as ATM machines, raiding 401K or IRA plans/ US retirement accounts) is the next thing to monetize now.

    Aug 26th, 2008 @ 1:28 pm

16. 16. Gates VP

    @Chuck: What I have done on occasion is turn off my pre-authorized contributions and used the extra cash flow to attack debt.

    When I moved and switched jobs I did exactly this just to help with cash flow. Again, it feels crappy to not be making deposits, but then I was back two months later increasing the amount because I have a larger income, so it balances out. In fact, I’ve increased contributions with every pay raise.

    @FT:One other factor to consider before doing something like this is that the amount withdrawn is contribution room lost forever.

    This is also a good caveat, but I must admit that unless you’ve been a frugal saver or you’re working a pensioned job, this cap is unlikely to matter for many people. I’ve been consistently saving 10%+ since I graduated University, but it’s highly unlikely that I’m ever going to hit my cap. I’d basically have to start saving 30%+ of my gross income to my RRSP for like 5 to 6 years (and I’m only 28). Now with the TFSA, you’re basically getting 18% + 5k year of tax free investments. And that’s just me, let’s not forget my wife’s unused portion. This is a likely a small consideration for most people.

    I think the big considerations are really interest rates and cash flow. It’s not just a raw numbers thing. If you don’t have the cashflow to service the debt then you need to find some way to pay it off. You have options:
    - consolidation
    - selling stuff
    - cutting expenses
    - cashing out savings (RRSP or otherwise)
    - stopping/slowing savings to pay down quicker

    Any combination of these options could be viable.

    Aug 26th, 2008 @ 1:38 pm

17. 17. Patrick

    (I made this comment once, but it seems to have disappeared, so I’ll try again…)

    @FT: I guess you could do what I did, and compute the break-even retirement tax rate that makes the withdrawal worthwhile. In the example I examined, I came up with 31.7%, which is a tad high, meaning the withdrawal is somewhat unappealing. The lower this number is, the more likely the withdrawal would pay off in the long run.

    Aug 26th, 2008 @ 2:08 pm

18. 18. Telly

    I’m not a big fan of withrdrawing from RRSP’s. We didn’t do it when we bought a home (though we didn’t have much put away anyway!) but admittedly, I did borrow from my 401k once.

    I borrrowed a small amount to pay off my student loans because the interest rate on the 401k loan was less than the interest on the student loan. Also, the interest paid on the 401k loan was paid back to myself. The fact that the loan payments came out of my pay cheque made it feel a little less painful even though I was paying it off very, very quickly and my take home pay dropped significantly.

    That being said, had I gotten laid off during that time, I would have been screwed!

    Aug 26th, 2008 @ 4:12 pm

19. 19. Traciatim

    @FT: Actually, I’m in Saint John, NB . . .not to be confused with St. John’s NL. Even this July the gains are still posted as over 12% YOY on the CREA stats page. The city has stagnated for a long time and is now catching a pretty positive vibe. (Especially with a nuclear plant expansion, new refinery, new nuclear reactor [possibly], and a large potash mine expansion really close together). Average sales price is still around 150K, which is reasonable for most families, not that I’m pimping my city or anything ;)

    Aug 26th, 2008 @ 6:01 pm

20. 20. Returns Reaper

    @GatesVP: You’re right. It’s difficult to contribute the maximum each year to RRSPs, and you have the means to do so, I’d argue it’s unlikely you have an excessive amount of credit card debt. And especially, as you point out, with TFSAs on the horizon, it is even more unlikely people will find themselves short on RRSP contribution room.

    To expand on my previous point a little further, I’ll attach some numbers. Basically, I’m considering that the cash flow that was freed up by paying off the credit card could be put back into the RRSP. Let’s compare the first example with a 5 yr. term. Unfortunately, I wasn’t able to figure out exactly what numbers FT came up with, but my numbers come pretty close.

    To pay off the $7k CC debt @ 12% in 5 years, you’d have to make monthly payments of $155.71. If you take out $11,667 from your RRSP now, you can pay it off, and start contributing the $155.71 to your RRSP. This means each year you’d contribute $1868.52. If you get an RRSP loan each year for $1245.68 your refund (assuming 40% MTR) will pay off the loan (we’ll neglect the interest on the RRSP loan for now. I think if you assume a reasonable interest rate line of credit is available and the money is only borrowed for a few weeks, the difference amounts to the $50 ball park over 5 years).

    So for 60 months, we’re contributing $155.71 monthly, and for 5 years we’re contributing $1245.68 annually. The monthly contributions on their own amount to a final value of $11,441.16, effectively covering the original principal withdrawn. The $1245.68 annual contributions grow to $7307.91 for a total of $18,749.07. Comparing this with $17,382 if the original $11,667 were left in the RRSP, and I think you come out ahead by almost $1,400 if you withdraw from the RRSP to pay off the credit card.

    Does this add up? The longer the term (i.e. 10 years, 15 years, etc.) the more compelling it is to withdraw the money to pay off the CC debt. For example, over 10 years, you’re almost $5k ahead in your RRSP.

    The higher your MTR is, the more compelling it is to withdraw to pay off the CC debt. With the same parameters as in the 5 year calculation I just did, if the MTR is changed to 50%, the benefit is about $2,000 over the 5 year term.

    The benefit to this strategy also improves as the gap between the RRSP growth rate and the CC interest rate increases.

    One other thing to watch out for is that if your MTR drops after the withdrawal, this strategy can backfire. But if it increases, your benefit increases.

    A caveat here though is that in order for this to work, the cash flow freed up by paying off the credit card actually has to be used for RRSP contributions. If it’s used to increase the standard of living instead (a tough temptation to resist), all bets are off. That alone may be an argument to leave the RRSP alone.

    Aug 26th, 2008 @ 7:59 pm

21. 21. Lucas

    What is the tax situation if you were to cash in some RRSP (say $5000) pay off debts and get things in order, then buy back at leat $5000 in RRSP before tax year end? Would you still suffer the same penalty? This is assuming that it would not change tax bracket by doing so.
    That way clearing up outstanding debts to make fresh start (assuming you can’t get a loan) Working contract work can sometimes leave gaps in income, but then a windfall later…but banks are not keen to give money (loans) during the between times!

    Sep 4th, 2008 @ 2:08 pm

22. 22. FrugalTrader

    Lucas, in terms of taxation taking out $5k from your RRSP, then redepositing later will result in $0 tax payable. However, there will be an initial RRSP withdrawal tax that will be returned to during tax season. Also, if you plan to have $5k to redeposit into your RRSP, why not simply leave the RRSP alone and use the $5k later to pay down debt?

    Sep 4th, 2008 @ 4:00 pm

23. 23. Lucas

    Thanks for answer….

    I would leave it alone but need to pay some bills now. Maybe I will just start with $1000 and see if I can spread that through until the November cotract starts up…but all the bills can’t wait that long! (That contract is a good one, so will put me back on my feet for a long time to come…just trying to fix some silly mistakes from the past at the moment)

    Sep 4th, 2008 @ 4:43 pm

24. 24. Patrick

    Lucas, I think you will also lose $5000 of contribution room.

    Sep 4th, 2008 @ 6:22 pm

25. 25. Lucas

    Well, even if I do lost that room, I have so much unused that I could put almost my whole salary in there (not that that will happen!) Good to know for future use. I don’t want to get any further in debt before my new contract, which is a long term one with a better salary, but have to fill the gap! Once that starts I can pay all past debt (isn’t huge, but annoying!), pay back the rrsp I borrow and will have enough coming in to get more too, but no where near my limit so I am safe with that.

    Great advice here though, was hard to find any information like this elsewhere.

    Sep 4th, 2008 @ 8:55 pm

26. 26. Four Pillars

    Lucas – given your situation, I don’t really see how you are really losing much (if anything) by doing a withdrawal and then a new contribution in 6 months. If you are at the same marginal tax level then it will be a wash.

    You do lose the contribution room but as you say, that isn’t all that important to you since you have so much.

    As FT mentioned – don’t forget about the mandatory withholding tax. On withdrawals up to $5k it is 10%.

    Ideally, someone with irregular income should have more savings (a TFSA will be great for this) that they can use to get through the dry periods.

    Mike

    Sep 5th, 2008 @ 10:13 am

27. 27. Telly

    Lucas,
    There is a form available online (CRA) that will allow you to withdraw RRSPs that you have not yet acquired the tax savings from (i.e. deposited them after the deadline at the end of Feb. 2008). I’m not sure if any of that $5000 was deposited in the last 6 months but that would be your best bet to tap 1st. Since you haven’t actually received the deduction yet, it won’t affect your contribution room.

    Another problem with withdrawing from RRSPs is that many people (myself and my husband included) keep most of their RRSP accounts loaded with stocks. Selling stocks in an emergency isn’t fun (especially in current markets) so unless you hold some bonds in your RRSP, best to make sure you can’t tap into any other funds first.

    Sep 5th, 2008 @ 10:47 am

28. 28. Travis

    Hi, I want to know if I should withdraw some of my RRSP Savings to pay off my CC. So here it goes:

    I owe $3500 on my CC @ 11.4%, I contribute $1200 a year to my RRSP, I have around 15K of RRSP’s. I make around 38K year, so if I borrowed out of my RRSP it would not bump me into the next tax bracket, I am from B.C. Canada, so I think im paying 33% taxes, I could be wrong. If I borrow from my RRSP I will need to take out $3,880, with the holding tax. I really want to get out of debt, and I have already consolidated once, but I just bought a place, so I had to spend on my CC. Once my CC is payed down I am going to lower my limit and budget myself. Sooo im not realy sure what to do.

    Oct 21st, 2008 @ 4:54 pm

29. 29. DAvid

    If you withdraw from the RRSP, you lose the contribution room, and pay the taxes (you would have to withdraw about $5200 to get $3500 once the taxes are paid). If you forgo this years contribution of $1200 and put it against your debt you will be at least that much further ahead. Reapet for the following two years and you are back on track. I suggest it would be cheaper to limit your budget now, and use the difference to pay off your credit card. You should also see if you can get a lower rate on your debt — maybe a LOC or HELOC?

    DAvid

    Oct 21st, 2008 @ 9:27 pm

30. 30. Jaco

    You are crazy..take the money out of the RRSP, pay off the bad debt.
    Take your monthy payment amount and start investing it immediately back into the RRSP.

    Show the calculation on that over 25 years.
    (include the annual income tax refund re-invested into the RRSP)

    Jul 23rd, 2009 @ 8:23 pm

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