Registered Retirement Savings Plans (RRSPs) are primarily meant to act as savings vehicles to help plan for Canadian’s retirement. However, while not their intended use, there are occasions where it may be justified to use those funds for non-retirement purposes.
A 2017 study titled “Canadians Using RRSPs to Fund Everyday Expenses and Debt Repayment”, published by BMO, reveals some rather unusual uses of funds that should otherwise have been used exclusively for their retirement.
{Also see http://www.cbc.ca/news/business/rrsp-bmo-poll-1.3971964 for a different version of the above table}
According to authors of the study, Canadians are dipping into their RRSPs for various reasons, including (18% of the respondents) to pay down debt. The question that might be on most people’s minds is: Is that a wise use of RRSP funds – Should you tap those funds for debt repayment?
It Depends!
That answer (“It depends”) may sound like a politically correct (PC) response, but it’s the correct answer. Whether it’s a smart move to use RRSP funds for anything other than to fund your retirement lifestyle (barring two specific exceptions!), really depends on what you are using the money for. If you intend to use it to service your debt, it may not be a wise move…and here’s why:
- Unlike a Tax-Free Savings Account (TFSA), the contribution room created from early withdrawal from RRSPs is forever lost. You don’t regain it like you do when repaying a withdrawal made from a TFSA!
- Early withdrawals made from RRSPs are added back to your taxable income for the year in which the drawings are made. That means that, since you are likely to be in a higher tax bracket (compared to if you were withdrawing the funds in retirement), you’ll pay much more tax on those withdrawals
- Early withdrawals from RRSPs are subject to withholding tax, ranging from 10% to 31% (depending on your province of residence) of the amount withdrawn.
Although the amount withheld is ultimately adjusted at tax-time, against tax owed by you; for the duration between the withdrawal date and tax-filing time that money (between 10% and 31%) isn’t earning any interest on your behalf. To put that in perspective, A $20,000 RRSP withdrawal in Ontario will leave $6,000 (as withholding tax) unavailable to you!
Most importantly though, the case against using RRSP money to pay down debt, or to fund pre-retirement lifestyles, boils down to math! Consider this example:
Over a 25-year time horizon, and assuming a 6% annual rate of return, if you regularly saved $10,000 annually in your RRSP, you’d have accumulated a nest egg of around $581,564. However, if you made a one-time withdrawal of $20,000 from your RRSP savings in year 10, to pay down a loan (or fund some other everyday expense), your nest egg at the end of year 25 would be just $505,353.
Even though you only withdrew $20,000, your RRSP balance is $76,000 lighter than had you not made that withdrawal in year 10. How come? It’s called the power of (or lack thereof in this instance) compounding! Since money grows TAX FREE inside an RRSP, even a small amount that’s let to stay there for a little longer, grows into a huge chunk of change because of compounded growth.
It Depends on What?
There are two situations where RRSP money should be considered for non-retirement use – and both are sanctioned by the government of Canada. Interestingly enough, both of these sanctioned uses amount to the government “loaning” you money from your RRSP savings!
- The Home Buyers’ Plan (HBP): In an effort to encourage homeownership amongst Canadians, the Federal government allows you to withdraw up to a maximum of $25,000 each calendar year (Jan to Dec), to use towards the purchase or building of a home. It is important to understand that this offer is extended ONLY to first-time homebuyers. You then have 15 years from the date of each withdrawal to repay that amount back into your RRSP
- Lifelong Learning Plan (LLP): The government also allows you to withdraw RRSP funds to finance your pursuit of education or training plans. There are certain caveats to this exemption: It must be for full-time learning, and you can only withdraw $10,000 a year – up to a maximum of $20,000. You then have 10 years within which to repay that “loan” back into your RRSP
Barring these two scenarios, funding a loan (or other day-to-day expenditure) by using RRSP money is ill-advised. So, if you do need to repay a loan (other than a first-time homebuying or an education-related one), what options do you have?
Your Options
A strategy to “borrow to repay” is never a good one, because it can lead you into an endless cycle of debt. However, if you do find yourself facing an unexpected situation, here are some options that you should consider for repaying that loan:
- Start building an Emergency Fund as soon as you can. In fact, even before you start saving for retirement, you should build your rainy-day fund. If you do need to repay a loan, consider dipping into this fund first – before you set sights on your RRSP!
- Depending on the interest rate offered, you could take out a short-term Personal Loan from your financial institution to fund the repayment of your other loan commitments. It may be a good idea to use an online Personal Loan calculator to do the math first, before you decide to travel down this path.
Remember: A secured loan may be less costly than an unsecured one. So, if you do have some collateral to offer (equity in your home, a car, other investments), consider putting them up as security for your loan
- You could also fund your loan by advancing money through your Credit Card. However, beware that interest rates for such borrowings can be much higher than the existing loan you are planning to repay. Once again, do the math using a credible online credit card calculator before you decide
If you can’t apply any of these strategies towards paying off that loan then, before you convince yourself that it’s time to tap into your RRSP, perhaps you should consider debt consolidation? While this strategy won’t directly help you fund your loan, it will buy you enough time to consolidate the amount owed with other lower-interest-bearing debts that you can then repay over an agreed period.
The take-away from this discussion is: RRSPs are meant to fund your retirement. Do not dip into that pot of savings unless it is the last resort. In the meantime, explore other available options to repay your debts. You’ll be pleasantly surprised at what you find!
