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Should I Withdraw from RRSP’s to Pay Credit Card Debt? RRSP Withholding Tax Explained!

I’ve gotten a couple emails from readers lately regarding getting rid of their credit card debt by withdrawing from their RRSPs/retirement account. My first thought was that it is a very bad idea. Before we start with the scenarios, lets look at some of the basics:

RRSP Withdrawals and Withholding tax:

Withdrawals from an RRSP account is added as income for the year which is then taxed at your marginal tax rate. To help pay for this year end tax, the RRSP withdrawals face an initial withholding tax. Note that the withholding tax applies to EACH withdrawal and not the total annual withdrawal.

  • 10% for the first $5,000
  • 20% from $5,001to $15,000
  • 30% for >$15,000

For Example, 40% marginal tax rate and $5,000 withdrawn would result in an initial withholding tax of $500, in addition to $5,000 added to reported income for the year. Providing that the extra income doesn’t result in a tax bracket jump, $5,000 x 40% – $500 = $1,500 owed at tax time.

With that explained, lets get back to the topic at hand with some scenarios.

Withdraw from RRSP to Pay Credit Card Debt?

Scenario #1:

Assumptions:

  • 40% marginal tax rate
  • Credit card rate: 12% (assume balance transferred to low interest credit card)
  • Monthly Minimum Payment: 3%
  • Credit card debt: $7k
  • Portfolio growth: 8%

In order to pay off the $7,000 credit card debt, approximately $11,667 [$7k/(1-MTR)] needs to be withdrawn from the RRSP to get $7,000 after taxes. That is providing that the withdrawal doesn’t put you into the next tax bracket.

Doing a few calculations, here are the results for the RRSP vs Credit card debate providing the assumptions made above and only the required minimum monthly payment is made:

Years: 5 10 15 20
RRSP Gain on $11,667: $5,475.49 $13,520.79 $25,341.97 $42,711.17
Credit Card Interest: $2,458.56 $3,190.12 $3,407.79 $3,472.56
Conclusion: Do Not Withdraw Do Not Withdraw Do Not Withdraw Do Not Withdraw

Interpreting the table above, it seems that for this particular situation, keeping the money in an RRSP is the obvious choice. Even if the minimum payment was made on the credit card for 20 years, the total interest would only be $3,472, whereas the potential portfolio gain would be $42,711.

Scenario #2:

But what if the situation was different? What if it was a year with lower income, credit card rates were higher and portfolio growth was predicted lower?

Assumptions:

  • 25% marginal tax rate
  • Credit card rate: 18.5%
  • Monthly Minimum Payment: 3%
  • Credit card debt: $7k
  • Portfolio growth: 5%
  • Withdrawn from RRSP: $9,333
5 10 15 20
RRSP Gain on $9,333: $2,578.63 $5,869.68 $10,070.00 $15,430.78
Credit Card Interest: $4,335.03 $6,130.54 $6,874.21 $7,182.22
Conclusion: Withdraw Withdraw Do Not Withdraw Do Not Withdraw

In this scenario, the table shows that the credit card interest would outgrow any RRSP growth for the first 10 years. After that however, the RRSP growth takes over with a big lead at the 20 year mark.

Since there are so many variables involved and so many different situations, I have created a RRSP vs Credit card spreadsheet to aid in the calculations.

As a rule of thumb though, most results would lead to keeping your money within your retirement account for the long term over using it to pay off the credit card debt.

Have you ever withdrawn from your RRSP to pay off debt?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 61 comments… add one }
  • The Financial Blogger August 26, 2008, 8:25 am

    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.

  • Traciatim August 26, 2008, 8:43 am

    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.

  • MoneyGrubbingLawyer August 26, 2008, 10:28 am

    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.

  • FT FrugalTrader August 26, 2008, 11:00 am

    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.

  • Gates VP August 26, 2008, 11:02 am

    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.

  • Patrick August 26, 2008, 11:38 am

    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.

  • FT FrugalTrader August 26, 2008, 11:48 am

    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).

  • nobleea August 26, 2008, 11:50 am

    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.

  • SM August 26, 2008, 12:00 pm

    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.

  • Chuck August 26, 2008, 12:02 pm

    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.

  • Patrick August 26, 2008, 12:06 pm

    @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.

  • Charles in Vancouver August 26, 2008, 12:20 pm

    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.

  • FT FrugalTrader August 26, 2008, 12:29 pm

    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.

  • Returns Reaper August 26, 2008, 1:08 pm

    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.

  • Dividend Growth Investor August 26, 2008, 1:28 pm

    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.

  • Gates VP August 26, 2008, 1:38 pm

    @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.

  • Patrick August 26, 2008, 2:08 pm

    (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.

  • Telly August 26, 2008, 4:12 pm

    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!

  • Traciatim August 26, 2008, 6:01 pm

    @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 ;)

  • Returns Reaper August 26, 2008, 7:59 pm

    @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.

  • Lucas September 4, 2008, 2:08 pm

    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!

    • FT FrugalTrader September 4, 2008, 4:00 pm

      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?

  • Lucas September 4, 2008, 4:43 pm

    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)

  • Patrick September 4, 2008, 6:22 pm

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

  • Lucas September 4, 2008, 8:55 pm

    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.

  • Four Pillars September 5, 2008, 10:13 am

    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

  • Telly September 5, 2008, 10:47 am

    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.

  • Travis October 21, 2008, 4:54 pm

    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.

  • DAvid October 21, 2008, 9:27 pm

    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

  • Jaco July 23, 2009, 8:23 pm

    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)

  • Stupid Stupid December 7, 2009, 9:30 am

    We ALL should have paid debt with our RRSPs before Sept 11, 2001, and again before Oct 2008. Then, after the market crashed, we could have bought back all our investments and be sitting high on the hog.

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

  • Leigh H February 4, 2010, 2:32 am

    I have used RRSP to pay off credit card debit in the past and have found it to be a double edged sword.

    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.

  • JMac101 August 3, 2010, 6:49 pm

    One variable that I think might be forgotten in this analysis is “SAVINGS”… When I say “savings”, I mean a pot of money (cash) somewhere to cover unexpected expenses (pipes burst, car accident, medical costs, have to attend a funeral accross country and pay a ridculous amount for a plane ticket last minute etc.) or save for future goods (furniture, vacations, home renos etc.), as opposed to savings for long term income (RRSPs, pensions etc.)

    I have about 12K on my LOC, but ever since I bought my house, I can’t seem to get it to go down in spite of making hundreds of dollars in payments each month. Because I’ve incurred this debt (foolish me!), and I’m socking money into it hand over fist, I haven’t been able to save much cash for short term goals/needs as defined above. So here’s the problem – every time there’s an unexpected cost (and there ALWAYS seems to be something!), I have no LIQUID savings to dip into to cover it, so I use my line of credit, which seems to have become nothing but a revolving door … put money in, take money out, put money in, take money out… all the while paying interest.

    (note, I do have a decent pension at work, and a about 30K saved in a variety of less than liquid financial vehicles (GICs, stocks, RRSPs etc.) plus my house (minus mortgage!)).

    So here’s my thought – I’m going to go on a financial “diet” for the rest of the calendar year and put as much cash into the LOC as possible (hoping to pay off about half), and in January, cash out an RRSP to cover the remainder. If I cash out in January 2011, I have the rest of the year to make contributions back into the RRSP to limit the impact on my 2011 income and taxes. Also, will only take out 5K or less to keep the withholding tax to its minimum 10%.

    My hope is that once the debt is paid off, the money that I’m currently using to cover monthly LOC payments can then be split between short term (liquid) and long term (not-so-liquid) savings. I know I’m losing the future income on the RRSP, but paying a few hundred dollars a month into a LOC that seems to be going no-where, with no indication that this pattern will change, I’d rather kill the debt, and take those monthly payments and use them to 1) invest and 2) build a small savings for unexpected costs and short term goals that will allow me to stay away from the LOC as much as possible. Maybe it’s psychological as suggested, but that stupid debt is keeping me from investing and enjoying life (feel guilty taking a vacation when have 12K cloud looming over head…)

  • Jane January 11, 2011, 4:41 pm

    I do not earn an income as I am a stay-at-home parent and have been for 12 years. I opened an RRSP 7 years ago using money left to me when my mother passed away. It was a spousal RRSP to help with my husbands taxes. I have never contributed to my RRSP since that initial deposit. Since then I have incurred a credit card debt of $9K. I want to withdraw the amount from my RRSP to pay it off. As I don’t work, I think it’s my best option. I can’t go back to work yet, my children are too young. What do you think?

    • FT FrugalTrader January 11, 2011, 4:48 pm

      @Jane, As you don’t have any other income, your withdrawal would face very little tax, however, it would still face the withholding tax. In my opinion, withdrawing funds during low income years to pay off high interest rate debt may be a good idea providing that the debt does not accumulate all over again.

  • Ed Rempel January 12, 2011, 12:06 am

    Hi Jane,

    Have you contributed anything to the spousal RRSP in the last 3 years? If so, then withdrawals could be taxed back to your husband. If not, then you get about $11,000 in tax credits each year (probably more in your case), so you will probably pay zero tax on the RRSP.

    If the credit card debt is at 19% or something like that, it is unlikely that you would make that much from your investments.

    The issue, though, is that most Canadians have far too little saved for their future and their retirement. Cashing in your future to pay off current spending is often questionable. I would suggest an option would be to cash in the RRSP to pay off the credit cards, but then take the amount you have been paying on the credit cards and contribute that monthly to your spousal RRSP to start building it for your future.

    Ed

  • Gates VP January 12, 2011, 4:52 am

    @Jane: I would echo Ed and FT here.

    You can probably withdraw RRSP money tax-free and it’s probably best to get rid of the credit card debt.

    The only way the withdrawal really works is if you plan to replenish the RRSP with money you would have instead spent paying for the credit card.

    However, with no income and kids to feed, I don’t see how that really does anything but push back the crisis. If you don’t have any income, what’s the plan to rebuild the savings?

    If you’re using the credit card to make the bills and you can’t go back to work, then it’s time to have a serious chat with your spouse / partner / family / money earner & figure out how to balance the budget.

  • Jose February 22, 2011, 2:21 pm

    I have read all your posts and used the spreadsheet but still unsure what to do.

    I have a 43000$ (multiple cards, all almost full to their limit) due to multiple bad issues in the last 2 years, right now I am barely making minimum payments, (once i n a while I missed payments) my credit record was A#1 and now is not the best.

    I have over 90K in RRSP at this time I could use to pay my debt once for all, but it seems it is not a good idea.

    As someone wrote in a previous post, banks used to call me at least once a week and they gave you as much rope so I can hang myself, this is my case now.

    I just sent an email to my advisor to close the RRSP and I will pay off the debt and have a better sleep at night, not thinking I will miss a payment or the debt will become in a huge GOZILLA mosnter.

    I plan to CUT ALL credit cards and keep only one, with a 2000$ limit and ensure that I change my spending habits. Pay CASH CASH CASH CASH CASH and MORE CASH!!!

    I feel pretty shitty right now, defeated and a failure but those feelings will soon be over when I will be able to sleep better at night.

    I will lose all those 90K room but at the same time, I have still about 50K in unsed room. Instead of making 1000$ month credit card payments will contribute at least 500$

    any thoughts??

  • Patrick February 23, 2011, 1:54 am

    Good for you, Jose. I think it’s the right decision.

  • FT FrugalTrader February 23, 2011, 9:51 am

    @Jose, note that if you do withdraw from your RRSP, the withholding tax will immediately be taken off the top, then you’ll need to save an amount for an increased tax owning at the end of the year.

  • Traciatim February 23, 2011, 11:24 am

    Jose, I also think it’s a good idea to shift the funds to pay off the debt, especially if that debt is at interest rates in the double digits. The key is to be responsible in the future and learn from the mistake.

    As Frugal Trader mentioned make sure you run the numbers through a tax calculator (like the one available on taxtips.ca ) and be absolutely sure you don’t rely on the withholding tax. If you take 90K out of an RRSP and it counts as income they will withhold 30% or 27K, but your tax bill would probably be closer to 35K-38K, depending on your income levels, so you don’t want to be surprised at tax time with a huge tax bill. Just a warning to make sure you are prepared :)

  • Jose February 23, 2011, 11:43 am

    @Traciatim,

    Yes You are right. Investment compnay is taken 31% of the 90K,
    (27900) to pay taxes. I have taken 45K to pay debt and the remainder 19% was left invested (17100) to pay taxes in 2012 at my taxe bracket which is the highest.

    It is hard, I just did my budget… OMG I was spending more than I was making per month…. lord gezuz!!! I am sooooooo cutting cost, its not even funny.

    Thanks god my job is very stable.

    thanks all for your feedback.

    I lost a battle but I learned a valuable lesson. Show must go on!!

  • HELOC Man March 24, 2011, 6:07 pm

    Here is one for you.

    I have a current RRSP balance of $119,326.08. Since inception (2005), it has made a return of 4.83%.

    Now, I have a HELOC of $97162 at 4% currently. I own my home (700K converative). The HELOC balance is used to purchase my cottage. I also have another 250K on a 5yr fixed mortgage at 3.49%. I kept the HELOC open so I could pay it down with extra $ without penalty as I have stock options, bonus etc at work.

    Now, if I assume the same return of 4.83% on the current balance of $119,326.08 for the next 10 years, that brings the balance to $191,245.50. This is a gain of $71,919.42. Now, say I’m in a 35% tax bracket when I cash thing out in 10 years when I have a little less hair. This means I am left with $124,309.58 in my pocket after paying the tax man as 35% tax is $66935.92. My “gain” is $4,983.50.

    The scenario is – what happens if I cash it now? Am I better off in 10 years of worse?

    OK, I am in the highest tax bracket of 46.41%. If I cash in $119,326.08, I have $63946.85 left to use in paying down my HELOC. This means that over 10 years, I pay $7139.29 in interest as opposed to $20,884.16. That is a difference of $13744.87. This is higher than the original gain of $4,983.50. Now, I am paying a bit more tax now as I cashing this in early when in a higher tax bracket, which is $11556.69 more.

    I am still a couple thousand dollars up even by taking the tax hit now.

    I realize that HELOC rates will go up and my RRSP return will go up and down. In my experience, this is crystal ball either way, so assume constant for now. Can I get a better return? Probably. Will interest rates rise? Yes. Will I be in a 35% tax bracket when I retire? Maybe. If all goes well, I’ll be in a higher bracket, then I’ll likely end up paying more tax anyway, which further says I should cash in debt now.

    Would like to hear comments on this.

  • Traciatim March 25, 2011, 12:11 am

    Hey Heloc Man, I’m not sure if it’s really worth it considering the disadvantages and the assumptions that are needed essentially eat away any benifit.

    How about two other options? Sell the assets but keep funds in the RRSP and use that to lend yourself your own money and pay your interest in to your own RRSP as a mortgage/LOC payment instead of a bank/financial institution.

    EIther that, or sell the assets to get the money out, pay off your debt, re-borrow the money to buy income producing assets (like didvidend paying stocks). That way you’ll be near the same scenario but your interest paid on the borrowed funds is tax deductible.

    Also, your first assumption states that you cash your entire RRSP in through one year, but that’s pretty bad tax planning.

  • J Saunders April 20, 2011, 11:44 am

    What to do in the case where I am in divorce proceedings. I have maxed line of credit, credit cards and with drawn about $25000 in RRSPs to pay legal fees.
    To continue on paying lawyers, paying minimum payments on 2 credit cards, and helping my university going child with some(not all) expenses I need to withdraw more RRSPs. I receive a retirement pension of about 2700 net per month-an early retirement due to disability.This will go down to $2000 or less in 5 years at 65.
    AI am paying 10% tax at source on $5000 withdrawls. But tax will be 30%, owing 20% now and so on.
    My husband is much wealthier than I , has several businesses and real estate assets but my lawyers never tried to get me interim support. It’s been one year and a quarter with nothing accomplished but a big surge on now to have various hearings and trial probably. What do I do now? DO I keep withdrawing all my RRSPs and what tax implications down the road if I di get a decent settlement?
    Thanks

  • Howie April 27, 2011, 11:20 am

    Here is my scenario:
    CC debt: 16 K
    RRSP (current): 37.7 K (12.3K in acc #1 (GIC); 25.4 K in acc #2 (group investment through work)).
    I contribute 5K every year (to acc #2) solidly through work (employer matches my contribution: 50-50 scenario).
    I’d like to withdraw all 12.3 from acc# 1 (GIC) and pay part of the CC’s 16 K balance (11.7 K after 20% withholding tax)
    With $500 every month (which I do every month) I can pay the remaining 6K within a year and be debt free.

    The CC debt is psychological for me – I got bad deal on my divorce (lawyers, new place etc.) and need to get that out of my system.

  • Tamara December 14, 2011, 3:54 pm

    Thank-you! I had been questioning whetehr to do it or not to pay off my debt. The stress of having debt looming, and making those monthly payments fars outweighs the stress of withdrawing my RRSP’s (at this point in my life anyway). I am young enough to do it, and your spreadsheet gives me the confidence to know that I made at the very least, an informed decision. Now that I have my money freed up from my debt, I can look at aggressively trying to repay it back, but also giving me a little flexibilty, as well a peace of mind.

    I think that more importantly, than any of this, is to teach people WHEN THEY ARE YOUNG the struggles with credit cards, debt, repayments and investments.

  • Kenny February 5, 2012, 1:11 pm

    Hi,
    My annual salary is 54K and I have 40K in RRSP. I will add 20K for 2013 tax year but I want to also draw 15K. How much it will effect. Is it OK? Please advise. Thanks.

  • Kenny February 5, 2012, 1:43 pm

    Hello,
    My question about RRSP investment. I invested 21000 in RRSP-GIC for 2years and annual % is 2.05 but where should I invest my RRSP amount to get more invest because 2.05% is very low. Please advise for the investment so that I can earn profit more. I can invest more than two years lock.Thanks.

  • Kenny February 5, 2012, 4:02 pm

    Hi,
    I have a question regarding tax return. My salary is 54500. Wife is house wife. Child are two under 4 years. I puuted 21000 dollar in RRSP for 2012. I will tax file in Ontario in Feb 2012. Now I want to know how much money will be tax return to me. Please advise. Thanks,

  • Yves Thomas March 12, 2012, 4:19 pm

    No, I suggest applying more money in the RRSP and use the tax refund to pay of the debt its a win win situation your RRSP’s go up and you can thank the government for that.

  • Sean March 15, 2012, 11:48 pm

    Ok I have 95k on a heloc @3% only paying interest @ $250 per month
    wife has 68k in RRSP,I have roughly 35k
    wifes salary is 64k per year and mine is 72K
    we are sick and tired of not paying this off and dont want to throw it back into our mortgage when we renew next year, 334k @ 2.6% with 14 yearsrs left.
    Should we cash in RRSP and pay down the HELOC? Ive heard of people cashing there RRSP in and spending them when they are younger and able to enjoy the money when they are in good health and have heard these same people say that if you have to much in RRSP the government is going to give you less in retirement (CCP old Pension, medicare etc etc…)

  • Gp June 5, 2012, 1:51 am

    it was just 3 yrs ago when i started rrsp.i contribute small amount to start with as i only have small income..my debt is more than my income..it was a bad year for me and i wasnt able to pay my debt coz i got layoff after a year whicb is i though i will be ok.couldnt find a job that time it was a ressesion year.and use CC to pay rent and neccessity i only have 3000 in my rrs,p thinking to withdraw them atleast lessen my debt im only working as a contract. do i pay big taxes if i withdraw my 3000.

  • Traciatim June 5, 2012, 8:11 am

    GP, the RRSP provider will withhold 10%. When you file your income tax you will pay tax as if you had earned that money this year, so it really depends on how much other income you have.

    If you actually read the article it explains how it works.

  • Big C July 30, 2012, 8:41 pm

    I owe CRA $30,000 for scams in gift donations, My wife has $100,000 in RRSP’s with $5,000 per year of income. Do I withdraw 1/2 out in tax year 2012 and again 2013 to pay the CRA

    Any thoughts

  • ABgurl November 4, 2012, 3:22 pm

    Okay- my 2 cents( and please note ,I am debtfree and always have been operating under this very basic principle). It does not matter HOW much one money one is saving whether it is as an RRSP, a savings acct,etc if you have even one oz of debt which you are paying ANY interest on. Think about it- if you save a dollar this month and put it in your savings acct but you have to pay Joe Blow a dollar in interest( and it is highly doubtful that Joe’s only getting a dollar but likely quite a few dollars compared to your one dollar that you managed to put that month in your savings!) on your loan- you haven’t saved a dime because while the one dollar is in your acct, you had to give a dollar for interest so on a balance sheet you are sitting at zero and its not in your favor.

    To me the smartest thing one can do is add up ALL your consumer debt( I am not including mortgage here) so you know precisely what you owe and if you have ANY savings anywhere ( ie: rrsps, saving accts, GICs, etc) pull them and pay off as much of that debt as possible. Hopefully you will be at square one – in that case THEN you can save and it will really be “saving”.

    In sum, you need to get yourself to square one of not owing anything ever again that charges interest on top of the principle ( again I am not including a mortgage but once at square one, you should in addition to saving make it a priority to get your mortgage paid off as quickly as possible) before you even think about trying to save a dime no matter what savings vehicle you use.

  • Jim December 8, 2012, 10:22 am

    Hi I am in desperate need of help. I am 23 years old and have $2300 on credit cards (was an 11% card but now its at 16%). It may not seem like much but it is enough for me to not always be able to make it on time for minimum payments as I have to take care of my girlfriend who is going through some immigration papers and cannot work.

    My question is I have $3000 in a RRSP which is now at $3350.
    If I take it all out to pay my credit card since I am in the lower tax bracket and it would not put me over. Would I take a huge hit and have to owe or since every year I have always received from tax return that it may just be a bit less?
    Do I just get the witholding tax and have the amount as yearly income?

    Will I only lose the room for the amount of the funds I took out.
    Basically if I pull it out, I cannot put it back in yet. Not for years until our income becomes more stable with 2 working people in the house.

    I need advice. Thanks!

  • Mishell February 15, 2013, 5:53 pm

    I am contemplating this…with some fixes in place so this will not happen again. In less than 2 years, we got married, went on a honeymoon, had a baby, lost $10K (a “friend” borrowed and didn’t pay back), I went on maternity leave for a year reducing my income to 40%, didn’t go back and was unemployed for 7 months and now am working full time but at 30K less than I was. We have racked up a lot of debt during that time, 50K on LOC and 18K on credit cards. We are at a point we can barely make our monthly payments (we have child support in there too) and I am thinking that by withdrawing and reducing debt (not fully but a lot) and cancelling all credit cards, it will give us a better chance to get back on track and start extra savings to a RRSP (in addition to our pensions). We are not young kids, so the time frame to build up again does concern me, but when stress from debt is consuming your life, where do you turn if you don’t want to go bankrupt?

  • Sabrina February 18, 2013, 10:57 am

    I received a $5300 performance bonus and lost a large portion due to taxes and deductions. I have both an RRSP and a defined pension and I am wondering if I would have been better off putting all or a portion of my bonus into my RRSP before tax and withdrawn what I need to pay down debt and have some cash flow.

    I earn approximately $45,000 per year and unfortunately I did not know my bonus amount until it was already applied to my pay cheque.

    On a $7800 gross pay my take home was on $4500. Would it have made more sense to blindly direct a percentage of the bonus into my RRSP?

  • Gates VP February 26, 2013, 4:12 am

    @Mishell: you say We are not young kids…, but you also say that you just got married and had a baby. Fresh baby means that you are probably working for the next 20+ years, so you have a lot of time.

    70k of debt is a very large load. In most of Canada, this is about 1 year’s worth of gross income for an entire family. Not sure what your income is, but that 70k number is worth considering.

    I have a comment near the top of the post, but I’ll just quote myself here:

    You have options:
    – consolidation
    – selling stuff
    – cutting expenses
    – cashing out savings (RRSP or otherwise)
    – stopping/slowing savings to pay down quicker

    Normally, the first step is to throw emergency cash at this type of thing, but you’re clearly past that. It sounds like you accumulated a lot of consumer debt without really accumulating a lot of “stuff”, so it’s not clear you can sell stuff.

    But your key problem is that you’re not making any headway. So on the left you have a large debt that is growing at rabbit speed and on the right you have a bunch of money growing at turtle. The left side is going to get bigger much faster than the right side.

    Barring something exceptional, the math does not leave you with many options other than to raid the savings and start paying down at least some of the debt. The only major downside is that you’re going to lose “lifetime cap” on your RRSPs. But that’s frankly a small concern, you’re way past that type of optimization.

    And then there’s the emotional weight of that debt. Living check to check trying to make minimum payments is emotional hell. You want to kill as much of that debt as you can.

  • Emmanuel February 28, 2013, 12:58 am

    It appears that you forgot to take into account the amount of taxes you will have to pay when you finally take those gains out of that RRSP/RIF.

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