Author Topic: Using rrsp to pay off debt... Crazy?  (Read 2923 times)

CanadianMustache

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Using rrsp to pay off debt... Crazy?
« on: March 14, 2014, 07:51:35 AM »
Hi

I'm wondering if it's ever advisable to withdraw from an rrsp to pay off debt? My husband was laid off and we used his severance money to pay of debt, but some of it had to be rolled into an rrsp.

He's 37 with about 135 k in rrsps. It's not a great amount for his age but I have a db pension with the federal government and have decided to maximise leave options here and there rather than retire early. I'd be retiring at 58 with (estimate) a 70k pension per year.

We were never viewing his rrsp as necessary, so are wondering if it makes sense to withdraw while he's earning no income and in a low bracket. Our debts are school and housing related (70k). His parents advise us to roll it into the mortgage, but I think that's worse than withdrawing from rrsp.

He's building his business and not making much money at the moment, so I don't see how we'd be able to pay it off otherwise as we're living on my income (65k). Im open to selling the house, but he's not as we're near elderly parents right now. Our house is worth 420 and we owe about 250k. Interest is 3.95

Any advice appreciated.

Interest on debt is average 6

totoro

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Re: Using rrsp to pay off debt... Crazy?
« Reply #1 on: March 14, 2014, 07:59:46 AM »
Yes.  In my opinion he should withdraw from his RRSP.  This money is tax deferred not tax exempt.

The basic personal exemption allows us to each earn about $10,000 a year tax free, if you had no other source of taxable income, you could withdraw this amount from an RRSP and effectively pay no tax.   This is a big bonus which is compounded if applied to interest-bearing debt.

Your financial institution will withhold 10%-30% for taxes when you draw the money, but you should get this back when you file taxes if you have no other income.

CanadianMustache

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Re: Using rrsp to pay off debt... Crazy?
« Reply #2 on: March 14, 2014, 01:24:01 PM »
Thanks for the quick reply totoro :-)

Prairie Stash

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Re: Using rrsp to pay off debt... Crazy?
« Reply #3 on: March 14, 2014, 03:36:11 PM »
No, I'm against the withdrawal. You haven't properly explored your options.

First off, get a HELOC. Roll the debt onto that, should be at 3.5% with 85K room (more than your current debts). After that you can start comparing rates.
Second, are you locked into your mortgage? Can you get a better rate?
Third - what are the tax implications of claiming him as a dependent vs. him withdrawing 10K? Pull out your tax forms for 2013 and do the math, see what difference in taxes it makes. 

If you do pull out of RRSP I'd suggest putting the money into a TFSA.  This blog is about retiring early, would you ever consider retiring at 50-55 (or earlier)?

Thegoblinchief

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Re: Using rrsp to pay off debt... Crazy?
« Reply #4 on: March 14, 2014, 06:49:58 PM »
Not familiar with the exact tax treatment here, but if it's penalty free money, I'd use it - but only for stuff over 5% interest. Otherwise you're losing out on compounding over time.

totoro

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Re: Using rrsp to pay off debt... Crazy?
« Reply #5 on: March 15, 2014, 12:07:46 AM »
Prairie has a good point with the heloc if you can reduce the rate on your debt 2 points.  Also correct on the need to do the math on claiming your spouse as a dependant.  It may save you $2000 or more in taxes which you could apply to the debt.     

You have to balance the heloc interest payments vs. expected return on the rrsps.  Also factoring in payments to debt via any tax savings.  I may have been incorrect on my math as I failed to factor in the spousal tax credit.

Ishmael

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Re: Using rrsp to pay off debt... Crazy?
« Reply #6 on: March 15, 2014, 05:44:03 AM »
You should take advantage of the low income year to get some money out of your RRSP. Remember, your future pension income is splittable* so he'll have taxable income when you are retired.

I'm assuming you're in Ontario, so it looks like after the basic exemption (~$12k) he'd pay a 21% combined tax rate up to $43k. I wouldn't take any more than that out in one year.

The point about the spousal deduction is a good one - you can use this calculator to help you out:
http://www.taxtips.ca/calculators/canadian-tax/canadian-tax-calculator.htm

I'm also assuming it's not a spousal RRSP - if it is, make sure it's been three years since you made any contributions into it.

You should also make a plan for your periods of time off. You should be entitled to 2 x 3mos and 2 x 1yr off without pay (for each type, there must be a 10-year separation between them though). There's two ways you can play it:
  • Take a full calendar year off (Jan-Dec), meaning you draw no income. You'll also have pension contributions and health care payments to make during this year. If you want to do this, you should be making RRSP contributions while working in addition to your pension so you can draw an income during your year off - the RRSP withdrawals will be done during the year off, when your income will be $0 otherwise. Since you have a nice pension, burning up RRSP room in this way shouldn't be an issue.
  • Take the year leave from June-May. This allows you to have two years where you'll be earning 1/2 your regular income, meaning those years will be better for income taxes.
Which one is better depends on how much income you need to pay your bills, and what you find playing with tax calculators. You probably won't be able to figure that out until your husband achieves a steady state with his business though.

And remember:
  • Start and end the the LWOP periods in the middle of the month if possible (i.e. where you have enough working days in the month to earn the vacation for that month).
  • You have to continue working afterwards for the same amount of time that you were of on leave - so don't plan on taking the year off just before you retire!

Also, for planning purposes remember that he will only get 1/2 your pension if you should pass away before he does.

As for the debt, figure out how to get the interest rate down, whether that's a HELOC or rolling into mortgage (they'll both have legal/filing fees associated with them, approx $1k. For $70K in debt though, it should be worth it as the interest savings will more than cover it over time).

I wouldn't pay off the debt though. Interests rates are ridiculously low, and cash flow is really important during stressful times. Having a pool of cash that should be earning more in investment growth than debt payments mean your net worth is increasing over time, plus a chunk of money allows you to sustainably make payments on the debt for a long, long time. If you pay it off, all your flexibility is gone. Since your plan involves having a steady income for a long time, I think managing overall risk is more important (i.e. if the Cons continue to wage their war on the Public Service - which every indication seems to be that they will.)

Here's what I mean - you use up most of your cash to pay off the debt, then the Cons take an axe to your position (because it doesn't matter if your work is valuable or not; indeed, they hate scientists the most despite the fact they do some of the most important work there is...). You'll still have a sizeable mortgage to pay, and your husband is building up his business. You might be forced to try and make a move (i.e. sell your house) in a shorter period of time than you'd feel comfortable doing, which is usually a recipe for losing money. (Note, however, that this will be mitigated by the severance lump sum that you'd receive.)

Personally, I'd be a fan of selling the house, assuming you can downsize and find something considerably cheaper. I just can't wrap my head around paying $400k+ for a house, plus the property taxes, insurance, etc on top of that. For comparison, I live on a huge acreage in the country with a large house that will have cost me a total of $125k when I'm finished renovating it.

And definitely make sure you take the LWOP (AKA "mini-retirements") along the way! Research has shown that the less time you spend working, the longer you live!!! http://www.economist.com/blogs/freeexchange/2014/01/working-hours

*Stupid Cons - how is this a sensible policy? Families with kids get no help, but seniors with large incomes get huge benefits. Talk about vote buying...

Hope this helps somewhat, and isn't just more confusing - I had to type in a hurry. :)

(PS - Sorry about the ranting against the Cons, but they've gotten so horrible that I can't hold myself back anymore...)