Conventional wisdom says it is a bad idea to borrow from retirement accounts, for lots of reasons. You lose years of tax sheltered compound interest, you often face early withdrawal penalties and additional taxes, and too often, the money is never paid back. Sometimes, though, the penalties for withdrawing retirement funds may be worth the cost.
This week, we decided to withdraw a (relatively) small amount from Bruce’s RRSP. Unlike 401(k) accounts, the Canadian RRSP allows you to withdraw early without penalty (other than paying income tax on the full amount). If you withdraw less than $5,000, there is 10% held back for income tax, with the tax balance due to be paid the following April when you file your income tax. If you repay the amount you withdraw before March 1 of the following year, you will face no tax penalties at all.
We withdrew less than $5,000. We withdrew the money because we have an appliance loan with a balloon amount owing by the 13th of June, and at this point I’m not 100% certain we will have enough cash to pay it off. If we do not pay the whole amount, we will owe about $6,000 in back interest, by my estimate. It may be a little less, but it will be somewhere between $4,000 and $6,000. That makes paying a 30% tax rate and losing 1-2 years of compound interest a minor irritation as opposed to a big issue. Am I currently re-thinking the Buy Now, Pay Later plan? Yes. But it’s too late to go back and change my mind now.
So long as we pay back the entire amount, we will get a nice little tax refund next year for the 10% that is held back (that we can then re-invest to make up for the loss in interest too). The only negative is the reduction in available contribution room, but Bruce has many years of past unused room to use up, (more than we will ever be able to use), so even this is a minor inconvenience.
The big risk is that we won’t pay it back. We have a plan (and a contingency plan!) to pay the loan back to the RRSP. I’ll be writing about part of the plan and about the contingency plan over the next few days. Either plan will provide us with enough cash to return all of the money we borrowed by March 1, 2013. So when I update our June debt, our appliance loan will be gone – but there will be a new amount instead, rather than a real reduction. Then over the next 9 months, we will work to reduce that amount to zero. I don’t like dipping into our retirement funds, but I refuse to pay 28.8% interest on 30 months!