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For Example, 40% marginal tax rate and $5,000 withdrawn would result in an initial withholding tax of $500, in addition to $5,000 added to reported income for the year.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In order to pay off the $7,000 credit card debt, approximately $11,667 [$7k/(1-MTR)] needs to be withdrawn from the RRSP to get $7,000 after taxes.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

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.
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Emmanuel
8 years ago

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.

Gates VP
8 years ago

@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.

Sabrina
8 years ago

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?

Mishell
8 years ago

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?

Jim
8 years ago

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!

ABgurl
8 years ago

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.

Big C
9 years ago

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

Traciatim
9 years ago

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.

Gp
9 years ago

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.

Sean
9 years ago

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…)