When the card interest charges exceed the money to be made in the RRSP in the short term, this seems to be a no brainer. However, I have regretted the decision to do so ever since. I have gone into detail below to help others looking at this option.

I had approximately 9K in credit card debt(@ an average rate of 14.9% over 3 cards) and approx 10K in RRSP savings- As my RRSP’s were not performing well and I was unable to add any money into them for 2 successive years due to financial constraints- I also was limited in the amount I could pay off my credit.for the same reason. I liquidated my RRSP and paid off the credit card, but, I did not have anything to replace the earning power of my RRSP (even 3% earnings were better than nothing) and it has been 5 years since I have been able to start putting money into an RRSP again. I put 10 K in last year and have been making 11% since I invested that, but, I could have made that return amount over the last 3 years with the funds I liquidated. So, Lesson 1: If your RRSP is underperforming now, that doesn’t mean it will keep doing so. Don’t get sucked in by moment-to-moment logic when it comes to your RRSP-they should always be examined in terms of the long-term plan.

Additionally, at the time I liquidated the RRSP, I owned my own home. I sold it shortly afterward due to divorce. I did not have any capital left over after the sale. Last year, when things were getting better, I tried to buy my second home but found that, since I had no significant savings (because: why pay off credit cards using RRSP unless you don’t have any other savings?) I qualified for significantly less and at a worse mortgage rate than my first home when I had 25K available in my RRSP (I used 15K as a first-time homebuyers advancement from my RRSP-still paying that back). It also has affected my car loan rate from my bank. My credit is immaculate over the last 15 years. Lesson 2: Savings are beneficial to you on more levels than just the simple math.

The tax withheld at source by my bank was 10% on all the funds I withdrew. With no way to redict the tax rate I will face when I retire and begin withdrawing funds, I choose, now, to add the 10% to the cost of using my RRSP’s to pay for my unsecured debt- to make the adjustment, I simply add the witholding percentage to the growth rate of the funds in my RRSP to calculate if this is a good idea for you.
Lesson 3: If it seems like a no-brainer, it probably isn’t when it comes to money management and the balance between debt and savings.

Lastly, I paid off the credit cards but still was living the lifestyle that led to the debt. I learned to change the spending habits that caused me the debt in the first place, but, it did not happen overnight and I incurred more credit card debt before I did. My spending habits were not that bad to begin with(no a drinker/partier, no drugs, no gambling, eating out 2-3 times a month- BEFORE I paid off the cards), but, I still needed to make some changes. I am reaping the benefits of the changes now, but I would have been better to make them before I paid off the debt. Lesson 4: Make changes to spending habits first but LIVE them for at least 4 months so they become part of your lifestyle before you take the $$ from your RRSP so you don’t jump back into the debit snowball making machine.

A credit card is almost a must to build a credit rating and perform many transactions. I have kept only one card active and, despite being offered a five figure credit limit, I have told the bank to shave the limit down to 3K. This amount is enough to get me on a plane in case of a family medical emergency and/or will pay for a household emergency repair of a plumbing/electrical problem. It is also sufficient to pre-pay for a vacation package reservation but is not so big that I can get myself into trouble. Lesson 5: The banks LOVE to give you enough rope to hang yourself with but are, generally, reluctant to help you out of the hole because they don’t make money on you that way.. They will allow you to accrue big debt so they can continue to make money on the interest they charge. Be firm that you want a low limit card and NEVER have more than one.

I didn’t take my own advice, and my RRSPs are now worth 1/2 their original value before 2001. Bah.

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.