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Home » Credit and Debt
DOES CASHING IN THE RRSP TO PAY DOWN DEBT MAKE SENSE?
Category :- Credit and Debt

Author :- mathew jazenko 
* Please rate and share the article if you find it interesting *

Posted on January 15, 2014, 5:36 pm
(3 Ratings)

This is a question that many people ask me quite often. My response: it depends on your situation. For some clients I say yes go ahead, for others I say forget it about cashing in the RRSPs. Some clients are in a high tax bracket, others are in a low tax bracket.

Before I go any further, it is probably a good idea to see how people got into debt in the first place. The student loan, this is a big one for students going onto post –secondary education while taking on massive student loans. The problem with student loans is repayments start within 6 months of graduating. In today’s tough job market, that is a tall order, considering most entry level jobs do not pay very well. Unless the student is graduating in a high demand field like engineering, etc.

Access to easy credit is another reason so many consumers get into debt very quickly with banks and retail stores offering money back if they sign up for XYZ credit card. Once consumers get this credit, then it is off to the nearest store to take advantage of that credit. Regardless is there is money available to pay for it once the bill comes in.

Homebuyers purchasing homes are going deeper and deeper into debt as house prices continue to rise. The blame for is the ultra low interest rates that push house prices even higher, pushing mortgage debt even higher.

RRSPS

The point that consumers fail to realize is that the highly overrated RRSP only kicks the taxes payable further down the line until that day comes when you retire. When retirement comes, most people will be at the same or higher tax bracket. Financial planners are guilty of telling clients that they will be in a lower tax bracket when they retire. When that pension cheque comes in from your employment, there will be no deductions taken for say employment insurance or Canada Pension or income tax. When tax time comes, watch out, that tax refund you are used to getting every year will be gone faster than a Justin Bieber tour bus. Of course standing next to you at tax time, is the tax man holding his hand out expecting his cut. Standing next to the tax man is a man dressed in a dark suit with sun glasses who represents the enforcer or ‘muscle’ to use mafia terminology.

TAXES

Governments at all levels are experts at raising taxes and fees like Canada Pension Plan payment increases, employment insurance increases and of course gas taxes. Taxes rarely go down and if they do there is a corresponding hike in fees somewhere else to make up the shortfall.

Having said that, let’s take a look at 2 cases representing the 2 most extreme cases.

 

CASE 1

Napoleon Bonaparte age 32 graduated from United Nations University in 2010 with a degree in military history.  Napoleon earns just $25,000 from his 3 part time jobs and owes more than $60,000 in student loans.  He currently has $10,000 in RRSPs and is currently paying back his loans at $200 per month and admits he won’t be able to pay it all back.

“When I was studying the outside world seemed oblivious. Now that I have graduated, I panic that I won’t be able to pay it all back’.

In Napoleon’s case it would make sense for him to cash in all of his RRSPs to get that loan amount down. That’s $10,000 less a withholding fee of 20% and $8,000 is left over to pay down that $60,000 debt. Granted, that Napoleon will have to report that withdrawal on his income tax at the end of the year.

Case 2

Cleopatra, age 45 works full time as a systems analyst at the World Bank in Toronto. She has mortgage and credit card debt of over $350,000.  She also has RRSPs of $35,000 which could be used to pay down that debt. In Cleopatra’s case, it does not make sense for her to cash in her RRSPs. The withholding tax will be 30% or $10,500. Instead Cleopatra could use her tax refund to pay down her debt.

Remember when you take that money out of your RRSP, you lose contribution room and cannot re-contribute the amount that was taken out. Consult a financial planner or your tax preparer before you take money out of your RRSPs. See if there is another way to get that debt down, after all, there are many strategies that one can take to reduce their debt including reducing spending on non-essentials.


Email to contact  : mathew.jazenko@accountingprofessionals.ca
Notes  : Mathew Jazenko is a GTA bookkeeper, tax preparer,blogger and speaker. Mathew specializes in helping small business owners improve their bottom line.
Twitter  : @mrjfinancial
Comments : Mathew is available for speaking engagements in and around the GTA. Mathew frequently speaks on *Debt *Taxes *Money *Invessting
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Tagged Keywords: RRSP, debt, cash in RRSPs, RRSPs

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