Most people by now understand the basics of an RRSP and how contributions benefit us, but what happens when it comes to withdrawals? What if you need the funds for some other personal matter? Wouldn’t pulling out some money you’ve saved make sense?
The short answer is no. RRSPs are designed as a retirement savings vehicle, not for vacations, cars, or other high-priced items. If you need to pull out some of your cash before you retire, the government will punish you in the form of taxes. Let’s look at the tax implications when you raid your RRSP.
Taxes paid when making early withdrawals
When you make an RRSP withdrawal, you’ll be charged withholding taxes by the Canada Revenue Agency. In Quebec, provincial tax will also be withheld. Here are the current withholding tax rates:
To put those numbers into perspective, if you live in Ontario and want to withdraw $25,000 from your RRSP to buy a new car, you’d immediately have to pay taxes of $7,500 (30%) and be left with just $17,500. To make matters worse, you’d permanently lose that $25,000 of contribution room.
Don’t forget, withdrawals from your RRSP count as income so you may need to pay additional income tax on top of the withholding taxes.
Making an RRSP withdrawal should be avoided since it’ll cost you a fair amount of money. If you’re in desperate need of cash, consider withdrawing money from a TFSA or high-interest savings account, refinancing your mortgage, or getting a line of credit with a lower interest rate. Regardless of what you decide, just make sure you think hard about your decision.
That being said, there are situations where you can make tax-free withdrawals.
Home Buyer’s Plan
First-time homebuyers can withdraw up to $25,000 tax free from their RRSP as part of the government’s Home Buyers’ Plan (HBP). This applies to each spouse or common-law partner, so as a couple you can withdraw up to $50,000 tax free.
There are some exceptions to this rule. First-time is a bit of a loose term since it really means neither spouse or common-law partner have owned a house in the previous four years. The amount you withdraw must have been in your RRSP for at least 90 days, and you need to pay the money back over 15 years.
Repayments start in the second year after you withdraw the funds for the HBP, and the annual amount to be repaid would be the amount you took out divided by 15. So if you withdrew $15,000, you would have to re-pay $1,000 a year.
Repayments don’t affect your RRSP deduction limit so you can still make regular contributions. If you can’t repay the minimum required, the amount will be considered income and taxed accordingly.
Lifelong Learning Plan
Similar to the HBP, the Lifelong Learning Plan (LLP) allows you to make a tax-free withdrawal from your RRSP as long as you’re using the money for educational purposes on a full-time basis. You and your spouse or common-law partner can withdraw up to $20,000 from your RRSP, with the only other rule being you can only withdraw up to $10,000 a year.
The LLP can essentially be used in three ways:
- for yourself
- both you and your spouse
- for each other
The funds aren’t limited to your tuition costs, so you could in theory spend the money on anything you want, but you can’t use it to fund your children’s RESP.
You have 10 years to fully repay the loan with 10% of the total amount you withdrew being the minimum per year. Repayments start as late as five years after your first LLP withdrawal. But in most cases, you’ll need to make payments before that time.
Failure to fully repay any withdrawals from the HBP or LLP will result in a permanent loss of that RRSP contribution room.
Sometimes people are absolutely strapped and must make the tough decision to withdraw money from their RRSP. Before you do, make sure you understand the tax implications and consider other options before touching your RRSP.
Flickr: KMR Photography