What happens to RRSPs in bankruptcy

You just declared bankruptcy. What will happen to your registered investment accounts?

The protection provided by Canada’s laws for registered investment products varies by type of account and the nature of the insolvency proceeding. We’ll focus primarily on Ontario.

RRSPs and personal bankruptcy

All provinces protect pensions well. For example, the Insurance Act of Ontario states that if an RRSP has a life insurance component, it is exempt from seizure if the beneficiary is your grandparent, parent, spouse, child or grandchild. This includes plans made up of segregated funds.

Prior to 2009, if the beneficiary was the debtor’s estate, these funds would have been at risk. But that year, the federal government changed insolvency laws to provide further protection for RRSPs. Now, funds that have been on deposit for longer than 12 months are protected. However, funds that aren’t otherwise protected by the Insurance Act can be seized if they were deposited in the 12 months immediately before you declared bankruptcy.

If you’ve made contributions to an RRSP in the previous 12 months that are now at risk of seizure, you must either: 1) request that your bankruptcy trustee arrange for these contributions to be withdrawn (the trustee will be responsible for paying any taxes owing as a result of that withdrawal prior to distribution to creditors); or 2) pay the trustee the equivalent of the expected realizations, net of taxes, and leave your RRSP intact. You could pay this amount in installments over the term of your bankruptcy.

Unlike RRSPs, other registered accounts (such as RDSPs, RESPs and TFSAs) are not protected from seizure under Canada’s Bankruptcy and Insolvency Act. Any protection they may be entitled to are set out in each province’s Executions Acts. In most cases, a trustee is able to claim these assets for creditors (including Ontario). However, Alberta has recently made RESPs creditor-protected.

The federal government recently began a five-year review of the Bankruptcy and Insolvency Act. It’s hoped the result will be enhanced protections for RESPs, RDSPs and other types of registered investment products.

RRSPs and consumer proposals

A consumer proposal differs from bankruptcy by allowing you to negotiate a debt settlement agreement with your creditors. The main benefit is that you can keep your assets.

If you file a consumer proposal, all assets remain in your possession, including TFSAs, RDSPs, RESPs and RRSP contributions from the previous 12 months.

What if you haven’t yet declared bankruptcy, but are in financial trouble?

There are two kinds of debt: secured and unsecured. Secured debts have some form of collateral pledged as surety for the debt. If you default, the lender has the right to sell the collateral. Fortunately, RRSPs can’t be used as collateral.

Debt that’s not supported by collateral is unsecured. In a default, unsecured creditors have the right of set-off (which lets a lender take funds from one account to pay down a debt in another) and recourse through the courts. But it doesn’t apply to registered investment products. So if you owe the bank for a loan, the bank cannot seize your RRSP for repayment.

Recourse through the courts means a lender can sue you to recover the debt. If the lender’s lawsuit is successful, the court will issue a judgment that’s usually followed by a Writ of Execution or a Writ of Seizure. These writs let a creditor seize bank accounts, garnish wages, and register a claim with a sheriff or bailiff. The writs don’t allow the creditor to seize RRSPs, but they may allow the seizure of other registered accounts such as RESPs and RDSPs.

If you’re in financial distress due to unsecured debts, don’t assume your best solution is to liquidate RRSPs or other protected investments. Depending on your situation, debt restructuring through a consumer proposal or perhaps an assignment in bankruptcy (i.e., using a trustee) may make more sense.

There are, though, cases in which selling registered investments to pay off debts and protect other assets that creditors can seize will be the right move.

Ted Michalos, B.A., CPA, is a Licensed Insolvency Trustee and co-founder of Hoyes, Michalos & Associates Inc. in Ontario, Canada.