RRSP Q&A: Can’t get rid of my debt, sell RRSP?

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From February 16 to 19, 2010, MoneySense.ca’s top financial planners are answering your RRSP questions. For the full list of questions answered — or to submit a question of your own — click here.

Using myself as an example — I am 30, making $72,500 per year with the federal government and have $13,500 in RRSPs.

I have bought a house with a 35 year mortgage and I am not paying extra on it because I have further debts accumulated from the purchase. My credit line currently has $4,000 on it and it has been hovering around that amount for about four years now, at between 4-6% interest over that period.

I put a significant amount each month towards the debt but it still accumulates due to life events, such as renovations, buying a car, taking a vacation, an upcoming engagement, etc. I calculate that at this rate, I would still require 2-5 years before I can pay it off and concentrate on the mortgage. Selling the RRSPs would allow me to pay it off, reduce further debt (engagement/wedding) and allow me to place money both on the mortgage and my TFSA.

Also how much could I expect to recover of the $13,500? —Flip

Karin Mizgala: I’ll start with your last question first.  At $72,500 you will pay $16,644 of tax (Ontario) and your marginal tax bracket is 32.98%.  If you withdraw $13,500 and add it to your earnings, your new income for the year is $86,000 and you will pay $21,959 of tax (an increase of $5,315) and your marginal tax bracket rises to $43.41%.  You will lose almost 40% of your withdrawal.  The take home value of the withdrawn RRSP is $8,185.  The tax numbers are based on only applying the personal credit to the calculations.

As to whether to withdraw the RRSP money or not, that depends on a number of factors.  You work for the federal government so I assume that you are in the government pension plan which is a very rich plan.  Also, if you stay with the government, the expectation is that your pay will increase which will allow additional savings.

Fundamentally, I am against withdrawing RRSP money because you will not recover the room and because part of the financial security in retirement will come from your own savings.  The long term compounding of this investment will produce a nice nest egg if you pay attention to it and make the money work for you.

There is no question that the TFSA is more flexible but I wouldn’t cash out my RRSP to put it into the TFSA.  You will probably not contribute to it given the fact that you have some debt that you want to get rid of.

My advice is leave the RRSP, draw up a budget and watch your spending.  To the extent that you can delay certain expenditures (perhaps vacations, upgrading your home, etc.), I would do so.  You are right that debt repayment should be a priority, but I wouldn’t tackle it at the expense of the RRSP.

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