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

DAvid

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.

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.

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

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

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)

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.

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!

@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.

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.

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.

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.

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.