
What if I use an RRSP as Security for a Loan?
A Registered Retirement Savings Plan is used to defer taxes on income earned to a later date. The idea behind an RRSP is that while you’re working, you are in a higher tax bracket than you will be later in life. So when you withdraw the funds down the road, it will be taxed at a lower rate. RRSPs are a very useful tax planning tool for your retirement. They are quite different from a TFSA, which is also a retirement tool. Please see here to review the differences between the two.
Withdrawal from an RRSP
Once you withdraw funds from an RRSP, the funds taken out are taxed as regular income. But, what happens if you don’t withdraw the funds, but rather pledge the account as security or collateral for a loan?
Using an RRSP as Security or Collateral for a Loan
If you want to take a loan from a bank, normally they will ask for some sort of security or collateral in case you cannot pay the loan back. The bank would then seize the security or collateral to satisfy the debt. If you pledge your RRSP as security or collateral, you may be costing yourself quite a large amount of taxes.
The reason for this is because by pledging the RRSP as security or collateral, you are unknowingly including the value of the pledged asset as income in the year of pledge.
What happens once the Loan is Repaid?
If you have included the loan amount in income, then once it has been repaid and the security is released, this amount can now be deducted from your income. This provides a good reason to pledge the RRSP as security or collateral rather than withdrawing the amounts. If you withdraw the amounts, you are unable to claim a deduction when the loan is repaid.
What happens if the Loan is not Repaid?
Typically, the bank or whoever provided the loan, will seize the pledged security or collateral to satisfy the debt. Since the income inclusion already happened, there is no second income inclusion.
If you are considering using your RRSP as security or collateral, please make sure you investigate the tax consequences before moving forward. You may, unknowingly, create a huge income tax liability that must be paid in the year this occurs. Tax planning may be very difficult for those who do not have specific expertise in the area. Should you have any questions regarding any of the above, Rosen & Associates Tax Law has the skill and experience necessary to guide you. Be sure to contact us today to learn more!
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.