How to handle debt when you want to retire
Dear Money Lady,
I'm planning on retiring at the end of this year. I will be receiving a company pension and also plan to start collecting CPP. I have no mortgage and own my home. Unfortunately, I have a significantly large balance on my home line of credit, about $320,000. I want to pay it off, but the only funds available are in my RSP accounts. What is the best way to withdraw these funds from my RSP accounts to pay off this debt and mitigate a large tax liability? Noah G.
Hello Noah,
There is no real way to reduce the taxation on your RRSP withdrawals. The only way to limit taxation would be to income split with a spouse or to move a portion of the funds to a home buyer's plan (which is not relevant in your situation).
RRSPS are a great tool for saving for retirement; however, they can also be a double-edged sword. The tax benefit you received when you first invested was a great way to lower your marginal tax rate and reduce your income tax; but never think for a moment that the government doesn’t want their money back. When you withdraw from your RRSP or RRIF you will always be subject to income tax.
You may also want to delay taking your CPP during the years that you plan to withdraw from your RRSP since this will only raise your income and move you into a higher tax bracket.
LIRA
An alternative may be your company pension. Why not convert your pension into a LIRA – which stands for a locked-in retirement account. The reason for moving it to a LIRA would be so you have full access to your pension amount to invest as you choose.
A defined contribution pension is relatively easy to transfer the whole amount to a LIRA however a defined benefit pension plan is different.
If you convert a defined benefit pension plan there’s usually a commuted value that is not transferable and can only be taken out as a taxable lump sum. This is the portion you could then use to pay down your line of credit.
You will still have to pay taxes on this withdrawal as income in the year you do your conversion, but it could allow you to leave your RRSPS intact to continue to grow over time.
PENSION CONVERSION
The other reason you might want to consider a pension conversion is if you question the long-term stability of your employer.
If you have any doubts that your employer might not be able to sustain their pensions, then that would be a reason to cash out early.
When you do your conversion, you are also entitled to withdraw 50 per cent of the plan amount as your firsttime take-out, as long as you are 55 years or older.
Each withdrawal after that will be based on a defined percentage for each year.
CAREFUL DECISION
Really, a decision like this needs to be discussed with your financial advisor or your banker and it should be mathematically determined if it’s worth it.
With interest rates now higher than ever and the Prime Rate over seven per cent, it may make sense to take the tax hit to eradicate your debt, so you don’t pay more in interest to carry the balance on your line of credit.
A $320K amount on a secured line of credit at the current prime rate would incur an interest charge of $23,040 over a year, or $1,920 per month.
If you do plan to consider a pension conversion, find out if your benefits are still valid when you cash out, and see if you can still income split to lower taxes. You may also want to find out if there are any limitations on the plan being provincially or federally regulated.
With interest rates now higher than ever and the Prime Rate over seven per cent, it may make sense to take the tax hit to eradicate your debt, so you don’t pay more in interest to carry the balance on your line of credit.
Good luck and best wishes, Money Lady