Using an RRSP as Security

“Using an RRSP as security for a loan may be a better alternative than cashing in the RRSP.”

Many Canadians make annual contributions to their registered retirement savings plan (“RRSP”) to accumulate funds for retirement. The road to retirement is often bumpy, and falling offside of certain income tax rules can turn some of these bumps into potholes.

Taxpayers in difficult financial positions will often withdraw funds from their RRSPs. This results in an income inclusion of the amount withdrawn from the RRSP, as well as a reduction in available retirement funds.

Some taxpayers have pledged their RRSPs as collateral or security for a loan, perhaps not realizing the tax consequences.

While doing this may allow an individual to obtain funds without withdrawing investments from their RRSP, the pledging of the RRSP (or of any investment within the RRSP) will result in the full value of the pledged asset or assets being included in the taxpayer’s income for the year.

For a spousal RRSP, the normal attribution of RRSP income to a spouse who contributed within the past three years does not apply to this type of RRSP income inclusion.

Depending on the financial situation, using an RRSP as security for a loan may be a better alternative than cashing in the RRSP. The RRSP income inclusion will be the same as if funds had been withdrawn from the RRSP but the funds will remain in the RRSP for further tax-free growth. If the loan interest is tax deductible the benefit of maintaining the RRSP may be higher.

Once the loan is repaid and the security is released, the amount previously included in income can be deducted. An individual would not receive this deduction if they had cashed in their RRSP since their contribution room is not replenished when funds are withdrawn from an RRSP.

If the loan cannot be repaid, the RRSP assets can be used to satisfy the loan without being included in income a second time.

One should never use their RRSP or any of its underlying assets as security for a loan without fully investigating the income tax implications.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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Cadesky Tax