When your debts weigh you down, it can be tempting to withdraw money from your RRSP to reimburse what you owe. Do you know what the consequences could be? Here are five examples:
Even if you have a good sum set aside for your retirement, you won’t be able to benefit from it in its entirety to pay off your debts. In reality, upon disbursement, the financial institution will deduct tax in the range of 21% to 31%. For a withdrawal of less than $5,000, the deductions are 21%. They are 26% for a withdrawal between $5,000 and $15,000 and 31% for a withdrawal of more than $15,000.
Therefore, by withdrawing $5,000 and aftertaking into account the deduction, you will only be left with a sum of $3,700 to reimburse your debts. On top of that, depending on the type of investment, your financial institution could charge fees for withdrawing funds.
If your taxable income is close to the upper limit of the tax bracket, any amount withdrawn from your RRSP could move you into the next bracket. For example, someone who earns $35,000 per year and withdraws $10,000 from his or her RRSP would move to the second bracket of taxable income that ranges from $41,935 to $83,865. It would be taxed at 20% instead of 16%.
When you disburse money from your RRSP, the contribution room that you were building will be lost forever. Once you regain your financial stability, you won’t be able to put that money back into your RRSP.
RRSPs are an investment that is meant to plan for a time in your life when it will be difficult, if not impossible, to work. For those who were fortunate enough to have contributed to an employer-sponsored pension plan for a significant part of their lives, the RRSP will serve as some extra money at the end of the month or a way to spoil themselves.
For others, especially those who are self-employed, it will be their only income source aside from the government pension plan. In discounting the importance of these savings, you might jeopardize your comfort during retirement or even your financial security at an age where unexpected health-related expenses, for example, may arise.
By withdrawing your RRSPs before you have retired, you also deprive yourself of the opportunity to grow your money over the long term with compound interest. For example, $7,000 that sits in an RRSP for 30 years with an annual rate of5% will result in earnings of $24,274 for a total of $31,274. Should you really deny your future elderly self that money?
In the vast majority of cases, withdrawing RRSPs to pay off debts is a bad idea. It’s better to look into the other options available to you.
First of all, you can tap into other savings that you may have such as a TFSA. You could also sell a few assets (your second car, your cottage) in order to pay off the debts that have the highest interest rates. Re-mortgaging your home or asking to consolidate your debts to get a lower interest rate than those offered by credit card companies and personal loans are also possible solutions.
Before you make a decision, it’s always better to meet with a financial advisor who can help you identify the best possible solution for your particular situation. They could also suggest tools to help youbetter manage your finances and strategies to avoid going into debt in the future.
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