What happens to RRSPs in bankruptcy?

Your client just told you they declared bankruptcy. What will happen to their registered investment accounts?

The protection provided under Canadian law for registered investment products varies by type of account and insolvency proceeding. Here, 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 the RRSP has a life insurance component, it is exempt from seizure if the beneficiary is your client’s grandparent, parent, spouse, child or grandchild. This includes plans made up of segregated funds.

Read: Should clients file taxes if they’re bankrupt?

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. Funds that have been on deposit for longer than 12 months are now 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 your client declared bankruptcy.

If your client has made contributions to an RRSP in the previous 12 months that are now at risk of seizure, he must either:

request that his bankruptcy trustee arrange for these contributions to be withdrawn.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
pay the trustee the equivalent of the expected realizations (net of taxes) and leave their RRSP intact. Your client could pay this amount in installments over the term of their 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 of the 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.

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Recently, the federal government began its five-year review of the Bankruptcy and Insolvency Act. As part of that review, my firm submitted a request to Industry Canada for RESPs, RDSPs and other forms of registered investment products to be given the same level of protection as RRSPs. We’re hopeful they’ll correct this inequality.

Consumer proposals are different

A consumer proposal allows your client to negotiate a debt settlement agreement with their creditors, the main benefit being your client can keep their assets.

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

What if your client has not yet declared bankruptcy, but is 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 your client defaults, the lender has the right to sell the collateral. Fortunately, RRSPs can’t be used as collateral.

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

Read: Rebuilding clients’ finances after bankruptcy

Recourse through the courts means the lender has the right to sue your client in order to recover the debt. If the lender’s lawsuit is successful, the court will issue a judgment, usually followed by a Writ of Execution or a Writ of Seizure. These writs allow a creditor to seize bank accounts, garnishee wages, and register a claim with the 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.

Should your client be financial distress due to unsecured debts, your client shouldn’t assume their best solution is to liquidate RRSPs and other investments that may be protected under the law. At the same time, your client may want to take action to protect any assets that their creditors can seize. Depending on your client’s situation, debt restructuring through a consumer proposal or perhaps an assignment in bankruptcy (i.e., using a trustee) may make more sense.

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