Are you considering filing for bankruptcy to deal with burdensome debts and rebuild your financial house? If so, you may be wondering how it will impact assets like an RRSP and TFSA.
If you’re like many Canadians, RRSPs, TFSAs, and other registered savings accounts make up a considerable chunk of your net worth. You’ve likely contributed to them for years to ensure financial security and a comfortable retirement. Not surprisingly, losing them to your creditors can be devastating, so it’s important to understand their treatment under bankruptcy before making your decision.
In this guide, we’ll explain the fate of your RRSP, TFSA, and other registered accounts should you choose bankruptcy to give yourself a fresh start.
What happens to an RRSP during bankruptcy?
Under Section 67 of the Bankruptcy and Insolvency Act (BIA), RRSPs are exempt from seizure by creditors, with the exception of contributions made during the last 12 months before your bankruptcy filing date. Since the BIA applies nationwide, the money in your RRSP is yours to keep, regardless of which province or territory you live in.
Additional protection for RRSP assets may also be available at the provincial level. For example, the Insurance Act of Ontario prevents creditors from seizing funds from an RRSP if it contains a life insurance component where the beneficiary is your spouse, parent, grandparent, child, or grandchild. This law applies to all RRSP contributions, regardless of when you make them.
What about spousal RRSPs and RRSP transfers?
When you file for bankruptcy, the rules governing RRSPs impact only your personal RRSP. As a result, you don’t have to return any contributions you make to a spousal RRSP, even those made within the last 12 months.
Transfers from one RRSP account to another don’t count as RRSP contributions, regardless of when they occur. Thus, your creditors cannot seize them.
How to deal with non-exempt RRSP contributions in bankruptcy
As discussed, all assets in an RRSP are safe from the clutches of creditors, assuming you’ve made no deposits within 12 months of your bankruptcy filing date. But what if you made contributions during that period?
In that case, you have three options:
- Withdraw your contributions. Once your bankruptcy begins, your trustee can arrange with your bank or investment company to withdraw any contributions you made to your RRSP during the past 12 months. Your trustee will pay the applicable withdrawal taxes on your behalf and disburse the remaining funds to your creditors.
- Buy back your contributions. If you wish, you can make extra contributions toward your bankruptcy estate to “buy back” the non-exempt RRSP contributions you made during the year. In this case, you would have to pay the total amount you invested for the 12 months, net of taxes. The rest of your RRSP will remain untouched.
- File a consumer proposal. Filing a consumer proposal will ensure that 100% of your RRSP assets (and assets held in other registered accounts) are safe from creditors. In a consumer proposal, you’re not required to surrender any assets to settle unpaid debts, which is one of the advantages it has over personal bankruptcy.
What happens to a TFSA during bankruptcy?
Though a Tax-Free Savings Account (TFSA) is a registered savings product, it doesn’t enjoy the same protection as an RRSP. TFSAs are available for creditors to seize to settle debts during bankruptcy. After filing for bankruptcy, you must surrender all TFSAs held in your name to your Licensed Insolvency Trustee.
Can your bank take money from your RRSP or TFSA to pay off debts you owe before you declare bankruptcy?
Let’s assume that you have an outstanding balance of $8,500 on your credit card that you hold with your bank. You have no financial means of repaying the debt. You also maintain an RRSP with a balance of $40,000 with the same financial institution. Can your bank take money from your RRSP to pay off your credit card balance if they believe you will file for bankruptcy?
The answer is no.
When your bank receives a bankruptcy notice from your trustee, it will check to see if you have any unsecured debts, such as a line of credit, credit card, bank draft, or personal loan. If you do, it can use the right of offset to recover the outstanding debt, effectively taking money from your bank account.
However, your bank can only exercise this right against your chequing and savings account—they cannot target your registered accounts, including RRSPs and TFSAs.
Contracts governing chequing and savings accounts have clauses that allow banks to use the right of offset to recover unpaid debts you owe them. But registered accounts aren’t bound by these clauses, as they’re separate contracts between you and the bank. As a result, you can file for bankruptcy without the threat of your financial institution garnishing your RRSP or TFSA beforehand.
Can you keep other registered accounts, such as RRIFs and RESPs, when filing for bankruptcy?
You may have other registered savings accounts that you’re concerned about if you’re contemplating personal bankruptcy. These may include a Registered Retirement Income Fund (RRIF), Registered Education Savings Plan (RESP), Registered Disability Savings Plan (RDSP), and Deferred Profit Sharing Plan (DPSP).
A RRIF, RDSP, and DPSP receive the same treatment as an RRSP in bankruptcy: all the funds in the account are off limits to creditors except for contributions you’ve made in the 12 months before your filing date.
However, depending on your provincial government’s laws, this privilege may not extend to RESPs. For example, in Ontario, the assets held inside an RESP are available for your creditors to seize, but in Alberta, they are not.
Locked-in pension plans are exempt assets under bankruptcy – creditors aren’t entitled to any money, no matter when you make contributions. Some examples are Locked-in Retirement Accounts (LIRA) and Life Income Funds (LIF).
What happens to pension savings in an employer-sponsored savings plan?
Do you have a sizable percentage of your retirement tied up in an employer-sponsored registered pension plan (RPP)? If so, the good news is that creditors cannot take a dollar out of your account, thanks to provincial legislation.
For example, under the Ontario Pension Benefits Act, funds held in RPPs are exempt from seizure by creditors during bankruptcy. All contributions you and your employer make to the plan are safe regardless of when they are made. The legislation applies to private companies and government entities providing RPPs to their employees.
The bottom line on RRSPs, TFSAs, and other registered savings accounts in bankruptcy
The BIA and provincial legislation provide generous protection for your registered savings accounts, especially those geared toward retirement, such as RRSPs. Only RRSP contributions made 12 months before your bankruptcy start date are at risk of being seized by your creditors. Assets held in registered pension plans sponsored by your employer also remain intact. As a result, declaring bankruptcy won’t wipe out your retirement savings. You can rest easy knowing you won’t have to rebuild your nest egg from scratch.
The downside of filing bankruptcy is that there is no creditor protection for TFSAs, either at the federal or provincial level. RESPs in provinces like Ontario are also vulnerable.
Given the profound impact of filing bankruptcy on your assets, including savings accounts, it’s crucial to weigh the costs and benefits of doing so. Depending on your financial situation, an alternative solution, like a consumer proposal, may work better for you. To learn more about your debt relief options, contact David Sklar & Associates to book a free, no-obligation consultation. We can help you determine the best path to deal with burdensome debts and get a fresh start.
