The inflation rate for January 2026 was 2.3%. Not far off from the Bank of Canada’s target rate of 2%. Though this is much better than the numbers we were facing just a few years ago, we’re still dealing with the fallout. Many Canadians are struggling to make ends meet. In fact, RBC survey findings report that nearly half of respondents were dipping into their emergency fund, and over a quarter are taking on debt just to cover their essential bills.
Those who do take on debt can quickly find themselves in over their head. Leaving them rushing to find a way out. Rather than struggling to repay your debt, it can be tempting to look to your RRSP funds for help. If you have been paying into an RRSP for some time, using those funds to keep afloat or pay off debt may be possible. Before moving forward, though, it’s important to understand the implications of using RRSPs to pay off debt.
What is an RRSP?
RRSPs allow Canadians to put capital into investments to help save for retirement. These investments include mutual funds, ETFs, and stocks. The program also offers some tax benefits. While these investments stay in an RRSP, you don’t pay income tax on any interest, dividends, or capital gains earned. Also, capital regularly contributed to RRSP is considered pre-tax. This means you can deduct the amount you contribute from your income, reducing your income tax burden.
Why you shouldn’t use your RRSP to pay off debt.
Though using an RRSP to pay off debt can be viewed as a good idea by some, doing so is often not the best idea. Cashing out the money in your RRSP to cover your debts is not ideal for many reasons. Here are some examples of why:
- Saving for Retirement Restarts. When using RRSP to pay off debt, you will have to restart the process of saving for retirement. Often, with considerably less time to save for your retirement.
- Lose Compound Interest. Taking money from your RRSP will prevent the accumulation of compound interest. This can mean facing a significant loss, as the building of additional interest is the main advantage of an RRSP.
- Withdrawn Money is Taxable. When capital is deducted from your annual income, it is not taxable as long as it remains within the RRSP. However, capital taken from the RRSP is fully taxable and must be added to your taxable income come tax time.
- Withholding Tax. Taking capital from an RRSP and using it for something other than purchasing a home or retirement will lead to a withholding tax. This tax means you’ll only receive a portion of the sum you withdrew. Leaving you will have less money to cover debts, and you will lose part of your savings to the government. Making this an expensive option to pay off debt.
The cost of using your RRSP – withholding tax
The RRSP withholding tax is charged when using RRSP to pay off debt before retirement. This tax reduces the rate of your return when withdrawing from your RRSP. The rates go up as the amount taken out increases.
The rates for the RRSP Withholding Tax are currently 10% if you take up to $5,000 from your RRSP. If the withdrawal is between $5,000 and $15,000, the rate is 20%. Anything more than a $15,000 withdrawal is subject to a 30% tax.
However, Québec residents also pay a provincial sales tax of 15%. If you are a non-resident of Canada, you pay a 25% withholding tax rate, regardless of the withdrawal size.
It is important to note that this won’t be the only tax you’ll face. Any amount withdrawn from your RRSP will count as income. This means that you have to input that amount on your tax declaration. If that additional income puts you in a higher tax bracket, you’ll have to pay more taxes.
Another downside is that you lose the RRSP contribution room and can’t re-contribute the money you take out of the account.
The taxes associated with using an RRSP to pay off debt make it only viable as a last resort. It is best to explore all other options to avoid these hefty fees.
RRSP Schemes
There are particularly nasty schemes out there that target retirement savings. They do so by claiming to offer various forms of tax-free withdrawals. These claims are fraudulent. They can be especially tempting to someone who isn’t thinking clearly because of financial stress and is desperate to find a solution. Don’t fall for them. It’s best to file them in your mind under the old adage of, “if it’s too good to be true”, because they are.
When should you use your RRSP?
There are a few instances where using an RRSP to pay off debt makes sense.
One instance is if you are using the funds to pay for your first home. Thanks to the Home Buyers’ Plan, you can withdraw up to $60,000 from your RRSP to use as a down payment for your first home. There is an important catch you’ll need to be aware of. You have to repay those funds within 15 years.
Another instance would be to use the fund to finance your education. The Lifelong Learning Plan enables Canadians to withdraw funds to pay for school tuition or other educational fees. Through the plan, you can withdraw $10,000 per year for a total of $20,000. With the Lifelong Learning Plan, you have up to 10 years to repay the funds.
What should you use instead of your RRSP to pay off debt?
All is not lost. There are lots of options available to help. For example, a Debt Management Plan, Consumer Proposal, or Bankruptcy. Each of these is designed to cut down, or even eliminate, your debt without affecting most of your long-term investments. Over time, these options can help you rebuild your credit score, which will open up more financial opportunities for you in the future.
When it comes to debt that has become unmanageable, any option you choose to deal with it (even the choice to not do anything) will involve facing some impacts. The impacts of these other options, while still not ideal, are less severe over the long term. This is especially true when taking the loss of compounding interest and the amount of tax you will pay out for withdrawing early into consideration.
All of this is why using an RRSP to pay off debt may seem like a good idea, but it is more of a quick fix than a solution. Doing so shouldn’t be done lightly. Careful consideration should be made so as to minimize or avoid serious issues down the line.
Wrap up
If you are struggling with debt and are thinking of using an RRSP to pay off debt, before moving forward, please take time to consider all your other options. Which one is right for you depends on many factors, like the amount of debt, the type of debt, and how far behind in payments you are. If you get overwhelmed trying to decide what to do, a Credit Counsellor, like the ones at Consolidated Credit, can help clarify the options and help you make an informed decision. They will review your situation and help formulate a plan that best suits you and aims to keep your retirement plans on track.
