While you’re allowed to make an RRSP withdrawal, there are often tax implications if you choose to take money out of your account before retirement.
First, you’ll pay a withholding tax when you make a withdrawal. The tax will be held back by immediately upon withdrawal by your financial institution and paid directly to the government on your behalf. The tax rate is between 10% and 30%, depending on how much you withdraw: In Quebec, the rate is between 5% and 15% but there’s also an additional 16% provincial tax you need to pay.
|Withdrawal amount||Withholding tax rate (excluding Quebec)||Withholding tax rate in Quebec|
|Up to $5,000||10%||5%|
|$5,000.01 to $15,000||20%||10%|
For example, if you live in Ontario and you withdraw $10,000 from your RRSP, 30% of that amount ($3,000) will be paid directly to the federal government. That leaves you with $7,000. However, you might have to pay additional taxes in the future.
“The tax that was withheld may not always be enough to account for the tax you owe at your tax bracket,” says the Canada Revenue Agency. That means you may need to pay more tax on the withdrawal when you include it as income on your tax return.
But there are a couple instances when you don’t need to pay taxes on RRSP withdrawals.
When RRSP withdrawals aren’t taxed
If the money you withdraw from your RRSP is being used for the Home Buyers’ Plan (HBP) or the Lifelong Learning Plan (LLP), then you won’t need to pay taxes on withdrawals up to a certain amount.
Under the HBP, you can make a tax-free withdrawal of up to $25,000 from your RRSP to help pay for the purchase of a home if you’re a first-time homebuyer. And if you buy with a spouse or common-law partner who’s also a first-time homebuyer, he or she can withdraw up to $25,000 for a total of $50,000. Any amount you withdraw must have been in your RRSP for at least 90 days.
The money you withdraw must be paid back over a period of 15 years. And you must pay at least one-fifteenth of that amount every year. For example, if you withdraw $22,500 from your RRSP, you deposit at least $1,500 into your RRSP every year ($22,500 ÷ 15 = $1,500). If you don’t repay any of some of the amount that’s required in a certain year, you have to include it as income on your tax return. The repayment period starts the second year after you withdraw funds from your RRSP. Also, HBP repayments don’t count as new RRSP contributions.
Under the LLP, you can make a tax-free withdrawal of up to $10,000 in a calendar year and up to $20,000 in total. The money you withdraw must have been in your RRSP for at least 90 days and can be used by you or your spouse/partner, but not your children. The student (you or your spouse/partner) must be enrolled in a full-time education or training program. However, if the student is disabled, his or her training/education can be done on a part-time basis.
You must repay at least 10% of the amount you withdraw over a 10-year period. The latest you can start making the payments is the fifth year after you make a withdrawal. However, it’s more likely that you’ll need to make payments sooner. If you can’t claim the education tax credit for three consecutive months in any given year, your first repayment will have to be made in the second year after the year of your LLP withdrawal. If you don’t make LLP repayments, the amount you don’t pay back is considered to be income. Repayments also don’t count as new RRSP contributions.
The bottom line
Making an RRSP withdrawal before retirement can be costly. Not only do you need to pay tax on the money you take out, the RRSP contribution room is permanently lost. But if you make the withdrawals under the HBP or LLP, you won’t be taxed unless you fail to make the required repayments.
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