Retirement: It's nice to get out of the rat race, but you have to learn to get along with less cheese.
~ Gene Perret
I've had a lot of inquiries about this lately, so I thought I would address it today. I've written about RRSP Basics and RRSPs vs. Paying Down Debt, but these articles dealt mainly with general issues and new contribution money. I haven't directly addressed the question of whether or not you should actually withdraw money from existing Resgistered Retirement Savings Plans in order to pay down credit card or mortgage debt.
Most financial advisors would consider it blasphemous to even entertain the idea of taking money out of your RRSPs. Now this might have something to do with the fact that their assets under management and resulting commissions would take a hit, but there are some very good reasons to leave your retirement savings alone:
- Once you retire, either because you want to or are forced to do so for health reasons, it will be a lot harder to earn more income to support your lifestyle.
- If you've managed to save some money so far, pat yourself on the back and leave it alone. Who's to say you'll be able to save as much in the future? A bird in hand . . .
- You will have to pay taxes at your marginal rate on the money you withdraw. (See RRSPs: Taking Money Out for a rundown on withholding taxes.)
- You will lose the RRSP contribution room for the amount you withdraw.
Situations Where You Might Consider RRSP Withdrawals to Pay Down Debt
Having provided the above caveats, I can think of a few situations where it might be worth your while to at least look at the math. There are quite a few variables here, so there's no one size fits all solution. If all else fails, remember the Cardinal Rule of RRSPs: they work best if your marginal tax rate is greater at the time you put the money in than when you take it out. Here are some factors that might lead you to consider an RRSP withdrawal:
1. Significant Increase or Decrease in Your Current Income
Perhaps you are a commission salesperson or self-employed individual and you just had a great year. Maybe you came into a significant amount of money from some other source, but you know this is a one-time deal. You may choose to put a lot or all of that income into an RRSP in order to shelter it from taxes. In a subsequent year, when your income is much lower, you may choose to take some of that money out (at a lower marginal rate) in order to pay down mortgage or credit card debt.
What if you took a year or two off work on sabbatical or for health reasons? Your income would likely be much lower (or nil) and you would pay far less tax on an RRSP withdrawal during that year. You could use that money to pay down debt, assuming you don't need it to live on while you're off work.
2. Significant Increase in Your Expected Retirement Income
Suppose your income at retirement is going to be quite a bit higher than you thought. Now that's a nice problem to have. If your future income and tax burden will be greater than your current income and tax burden, you might consider taking money out of your RRSP to pay off debt – although I'm not sure how likely it is a person who has saved so well would still have any debt.
3. You Suspect You May Have Too Much Money in RRSPs
If you started saving in the 90s like we did, you probably got caught up in the “everyone needs to put their money in RRSP mutual funds” tidal wave that swept the globe at the time. If that's the case, you may find yourself with too much money in RRSPs. How could you have too much money?
Well, if you have so much saved that your tax burden when you withdraw the money in retirement is equal to or greater than it was during your working years, there is really no benefit to sheltering that money in an RRSP. The CRA is still going to get its pound of flesh, and part of me would rather give it now while I can still earn income rather than later when I may not be able to do so.
4. The Interest Saved on Debt Is Greater Than the Tax Paid on the RRSP Withdrawal
If you feel you have over-invested in RRSPs and you have debt that you want to get rid of, it may make sense to see how much the withdrawal will cost you in taxes relative to the interest savings you'll receive by paying down your debt. Obviously, if you pay down credit card debt your interest savings will be a lot higher than if you pay down your mortgage. It all depends on the interest rate you're paying on your debt.
See The Cost of Debt for some interesting math on this topic. (Is interesting math an oxymoron?) And check out some of the calculators in the Resources section here at Balance Junkie. There is no one correct answer to the question, but you can have better odds of getting it right than a coin toss if you do a little research.
One More Caveat
If you choose to take some money out of your RRSP to pay down debt, you must be absolutely certain that you won't take on more debt. If you pay off your credit card balances, make a pledge to never carry a balance again. If you can't pay it off in full, don't buy it. If you pay off your mortgage, promise yourself that you will use at least a good portion of the money that went to your mortgage payment to boost your savings. If you don't trust yourself and/or your partner to exercise that kind of discipline, then it's probably better to leave well enough alone.
Would you ever consider taking money out of your RRSP to pay down debt?