A Registered Retirement Savings Plan (RRSP) can be a savvy way to save for your future. Your contributions can lower your taxable income in the year you invest, and the deposited funds grow tax-free until you withdraw them in retirement.
But when you need cash — whether to pay down debt, supplement your emergency fund or pay for a major purchase — you might wonder if you can borrow against your RRSP. After all, wouldn’t it be great if you could use the pot of money you’ve so diligently nurtured and grown over the years as collateral for a loan, allowing you to enjoy the benefits of a tax-sheltered vehicle while also tapping into its value when needed?
In theory, it’s a good idea. Unfortunately, in practice, using an RRSP as collateral is limited and can carry serious tax consequences.
Key Points
- Generally, RRSPs cannot be used as loan collateral due to legal restrictions and tax implications.
- The government typically discourages registered accounts with tax advantages, like RRSPs, from being used for purposes unrelated to long-term savings goals like retirement.
- An RRSP loan is a type of personal loan used to contribute to your RRSP account, helping you maximize tax deductions and grow retirement savings.
Learn more: RRSP Guide In Canada.
Can I Use My RRSP As Collateral On A Loan?
To determine whether you can use your RRSP as collateral, you’d first have to determine whether it’s a locked-in or non locked-in registered account.
Locked-In RRSP
A locked-in RRSP is usually the result of a transfer of pension funds. These types of accounts are subject to strict regulations. The Pension Benefits Standards Act, 1985 and the Pension Benefits Standards Regulations,1985 prohibit any assignment, pledge, or use of locked-in funds as loan security.
Therefore, a locked-in RRSP could not be used as collateral under any circumstances. This is to ensure that pension funds fulfill their original purpose, which is to provide income in retirement.
Non-Locked-In RRSP
You can technically use a non-locked-in RRSP as collateral for a loan, but doing so comes with serious tax consequences that would essentially nullify the purpose of having an RRSP account.
The government wants to encourage individuals to use tax-favourable accounts to save towards retirement and will thus deter them from using these accounts for other purposes, like securing loans. Under Canadian tax law, pledging your RRSP as security is considered an “advantage” by the Canada Revenue Agency (CRA).
That means the full value of the funds used as collateral would be treated as taxable income in the year you make the loan, effectively cancelling out the tax benefits that make RRSPs so valuable in the first place. You’d then have to deal with a hefty tax bill in the year you took out the loan, meaning your loan could end up increasing your money problems rather than easing them.
| What Are The Perks Of Using Your RRSP As Collateral? In the limited cases where your RRSP is not locked in and a lender is willing to accept it as collateral, there are a couple of potential advantages: Funds Remain In Your Account: While you would have to declare your RRSP asset as income, you aren’t actually withdrawing money from the account. The funds nonetheless remain in the RRSP, and even though you’ve had to pay income tax on the fair market value of the asset in the year you get the loan, the money continues to grow in a tax-deferred vehicle. Preservation Of Contribution Room: If you simply use your RRSP as collateral without withdrawing from it, you might avoid reducing your RRSP contribution room. Furthermore, if you repay the loan in full and the financial institution releases your RRSP from collateral, you can then claim a deduction for the same amount you initially included in income. |
Borrowing Against Your RRSP Vs RRSP Loans
It’s important to understand the difference between using your RRSP as collateral for a loan versus an RRSP loan. These two concepts sound alike but have completely distinct purposes.
| Borrowing Against Your RRSP | As discussed, borrowing against your RRSP is when you use your RRSP as an asset to secure a loan. |
| RRSP Loans | An RRSP loan, on the other hand, is when you borrow money from a bank to contribute to your RRSP so that you maximize your tax-deferred growth. You’re not using your RRSP as collateral but are rather looking to increase how much money you invest in your RRSP. Once you get the loan, you deposit the money into your RRSP and then use the resulting tax refund to pay off your loan. |
Learn more: RRSP Loan: The Good And The Bad
Can I Borrow Against Other Accounts Instead Of My RRSP?
In general, the government wants to discourage the use of registered accounts with favourable tax benefits — like First Home Savings Accounts, TFSAs, and RRSPs — from being used for tax avoidance and other unintended purposes other than to save for retirement (or, in some cases, a home).
There are financial institutions that offer products, like investment secured lines of credit, that can be attractive options for those who want to borrow money. Essentially, you use your investment accounts as collateral to secure a loan.
For example, TD’s Investment Secured Line of Credit allows clients to use eligible investment products as collateral to borrow at more favourable rates than with an unsecured line of credit. RBC has a Royal Credit Line, where clients use either their home equity or investment portfolio to secure a line of credit with better rates and higher limits than their unsecured line of credit.
Pros & Cons Of Using Your Investments As Collateral
Using your investments as collateral can unlock access to credit at lower interest rates, but it also exposes your assets to risk if you default. Consider the following before adopting this strategy:
Pros
The following are some perks of using investments as collateral:
- No Need To Liquidate: Take advantage of the “buying power” of your investment account without actually having to sell it.
- Avoid Capital Gains Taxation: You can borrow cash without triggering capital gains taxes from selling appreciated assets.
- Leave Investments As Is: Your investments remain in the market and can continue to grow.
- Better Rates & Terms: You’ll enjoy lower interest rates and better terms than you would with unsecured personal loans or credit cards because they are secured.
Cons
Carefully consider these potential risks of securing a loan using your investments:
- Risk Of Asset Depreciation: If the value of your investments drops, you may be required to deposit more collateral or repay the loan immediately.
- Forced Sale Risks Loss: If you can’t meet a margin call, the lender may sell your securities, potentially at a loss or during a downturn.
- Potential Ineligibility: Some accounts (like retirement accounts or restricted stock) may not be eligible.
- Restricted Collateral Trading Rights: You may not be allowed to trade freely with the collateralized securities.
- High Appetite For Risk Required: Borrowers who use investment accounts as collateral need a high risk tolerance due to market variability.
Should You Use Your RRSP To Pay Off Debt?
You could use your RRSP to pay off debt, but such a move often comes with significant tax costs. When you make withdrawals outside of retirement, you’re immediately subject to a withholding tax as follows:
- 10% (5% in Quebec) on withdrawals up to $5,000
- 20% (10% in Quebec) on withdrawals between $5,000 and $15,000
- 30% (15% in Quebec) on withdrawals over $15,000
This tax is withheld by your financial institution as a prepayment of the income tax you may owe.
Keep in mind that RRSPs are intended to help save for retirement. While you can officially take out money at any time, ideally, you’d only make withdrawals once you’re retired and in a lower tax bracket.
If, however, you’re struggling with very high interest debt (like credit card debt or a payday loan), it may be worth taking the tax hit. Just take some time to consider all your options first.
| Exceptions To Withholding Tax Rule Keep in mind that there are two exceptions to the withholding tax rule: – Home Buyers’ Plan (HBP) – Lifelong Learning Plan (LLP) Both programs allow you to withdraw from your RRSP without paying taxes upfront, though you do have to repay the funds within a set time. |
Learn more: What Is The RRSP Withholding Tax Rate?
Impact Of Withdrawing Your RRSP Early
With few exceptions, RRSPs are intended for retirement, with withdrawals made when you’re in a lower tax bracket. By accessing funds before retirement, you risk several negative consequences, including:
- Withholding Tax: As noted, your withdrawals will immediately take a hit when your financial institution claws back anywhere from 10% to 30% to cover income tax.
- Year-End Tax Implications: The total amount withdrawn is added to your taxable income for the year, which can push you into a higher tax bracket and increase your tax bill significantly.
- Impact On Government Benefits: Because your withdrawals increase your income for the year, you could move up into a higher tax bracket. This can negatively impact your eligibility for government benefits like Old Age Security (OAS), Guaranteed Income Supplement (GIS), and the Canadian Child Benefit (CCB).
Alternatives Options
Trying to get out of a mountain of debt? Consider these options:
Debt Consolidation Loan
A debt consolidation loan combines several high-interest debts into one, lower-rate loan. This makes payments more budget friendly and easier to manage because you just have to keep track of one monthly payment.
Balance Transfer Credit Card
Credit cards will sometimes offer low- or 0%- balance transfer promotions (sometimes with a small fee) where users can take advantage of a low rate for a set period of time. This provides much needed breathing room to chip away at payments.
It’s essential to pay off as much debt as possible before the promo ends and jumps to a standard high credit card rate of interest.
Home Equity Loan/Line of Credit
If you own a home, you can opt for a home equity loan or line of credit. You use your property’s fair market value as collateral for a loan of credit or loan, which ensures you get favourable rates, a large limit and good terms.
However, if you default on payments, you risk losing your home.
Bottom Line
While the idea of borrowing against your RRSP may sound appealing, doing so could have major tax consequences that could far exceed any benefits of having access to quick cash. If you’re struggling with debt, consider getting a debt consolidation loan or applying for a secured line of credit using your investments as collateral. Remember: an RRSP is intended as a way to save long-term for retirement, so be sure to carefully consider all options before using it as collateral.
