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Retirement: 6 misconceptions about debt, clarified

Article updated on 19/08/2019
You’re retiring in a few years but instead of dreaming about retirement, you’re just worrying about your large debts. It’s normal to be concerned. But you should think positive: There’s hope. You just need a good plan and the correct information.

Summary

Retirement: 6 misconceptions about debt, clarified
  • To get the most out of your retirement, it’s important to effectively manage your debt while you’re still working.
  • Using your RRSPs to clear your debt isn’t going to help you in the long run. It’s expensive from the moment you withdraw, and carries long-term repercussions.
  • Declaring bankruptcy doesn’t mean losing your retirement. It’s actually possible to rebuild financially after bankruptcy. RRSPs are also protected from creditors (under certain conditions).

Here are six clarifications of common misconceptions about debt and retirement.

Not-so-good Idea No. 1: Paying off your debts with your RRSPs

It’s easy to see your RRSPs as money within easy reach. Withdrawing that money to cover your debts, however, is a bad idea. There are a number of reasons why.

First off, you will have to pay a withholding tax. That means that at the moment you withdraw money from your RRSP, your financial institution will withhold part of that amount to remit to the government. This estimated tax amount (around 30% of the amount withdrawn) will go to the federal and provincial governments.

Then at the end of the year, you will have to declare the amount you withdrew as part of your income. This means you might have to pay even more tax on the money you take out.

Second, the Bankruptcy and Insolvency Act makes RRSPs unseizable for creditors. The goal of this act is to protect the retirement of anyone facing overindebtedness. This act specifies that RRSPs must never be used to pay debts. Their purpose is to ensure you enjoy a good quality of life during retirement.

Essentially, digging cash out of your RRSP means slashing your retirement fund. The moral: Protect your RRSPs! If you don’t, you’re putting your future at risk.

Not-so-good Idea No. 2: Using your retirement as a time to pay off your debts

This isn’t so straightforward, as you will have a reduced income during retirement. This applies to everyone: We should all expect to earn less during retirement. It’s worth noting that even retirees with big RRSPs and generous pension funds receive around 70% of their previous salaries.

The bottom line: If you’re already struggling to pay your debts, it will be even harder once you stop working. It’s better for you to take care of things now.

Myth No. 1: If I declare bankruptcy, I’ll lose my savings and RRSPs.

This is far from the truth. The following cannot be seized in the case of bankruptcy:

  • Your pension funds
  • Your RRSPs (except your contributions from the last 12 months)
  • Your RRIFs (registered retirement income funds)
  • Your LIRAs (locked-in retirement accounts)

In short, even if you declare bankruptcy, there’s a way to preserve your retirement.

Myth No. 2: I’ll never be able to get back on my feet before retiring if I declare bankruptcy or file a consumer proposal.

This too is absolutely untrue. Bankruptcy and consumer proposals are temporary—there’s a life after!

A first bankruptcy lasts from 9 to 21 months and a consumer proposal lasts a maximum of 5 years. At the end of the process, you’re debt-free! It’s your opportunity to start anew and begin putting money aside again. And even if you continue to have a note in your file for a few years, you can still gradually rebuild your credit with good financial habits.

Myth No. 3: I won’t have any income during retirement if I declare bankruptcy.

False. In Québec, you’re guaranteed a minimum retirement income. Where does it come from? It’s your retirement pension from the Québec Pension Plan and the federal government’s Old Age Security Program. It’s a base.

However, even when added together, these amounts are nothing huge. Most of the time, they aren’t enough to let you maintain your standard of living. That’s why it’s important to protect your RRSPs. It’s also a good reason to review your budget.

Whether or not you have RRSPs, you will have a lower income during retirement. A lower income means you will have to lower your expenses. To ensure a balanced budget, you can use our online budgeting tool.

Myth No. 4: I have to settle 100% of my debts before I retire.

This isn’t totally true. But it isn’t totally false either. Of course retiring debt free is ideal (if you’re not sure why, prefer back to Not-so-good Idea No. 2). But sometimes it’s just not possible. The important thing is to follow this advice: Clear your high-interest debts as quickly as you can.

Credit card debts that have interest rates between 19% and 29% are an example of high-interest debts. Focus on these first, as they have a major impact on your monthly budget. The longer you wait to pay them, the higher they’ll be. They’ll also be hard to leave behind once you retire.

Having low-interest debts is a less serious problem. These debts include a mortgage on your house or lease on your car. Why are these a less serious issue? Take this example: If you borrow at 3.5% to pay for your home but the return on your RRSP is 4%, this means your savings are growing at a rate higher than that of your mortgage.

That said, every situation is different. Even if these are low-interest rates, accumulating debts are accumulating debts! You still have to pay them at the end of each month.

This is why it could be a good idea to sit down and properly take stock of your debts. You can do this right away using our diagnostic tool. Another option is scheduling a meeting with a counsellor.