The Registered Retirement Savings Plan (RRSP) provides Canadians with a practical way to save for their retirement.
RRSPs have various rules that govern how they are administered. Generally, you can make a withdrawal from your RRSP account at any time, however, depending on the situation, there are usually tax consequences and you could also lose your RRSP contribution room.
RRSP Withdrawal Rules
While RRSP funds are supposed to be one of your key sources of income in retirement, there are certainly other potential ways to spend the money…at any time.
Whenever you take out money from your RRSP account, the amount is added to your income and taxed immediately using specific withholding tax rates.
There are two ways to borrow money from your RRSP tax-free through the home buyers’ and lifelong learning plans (more on these in a bit).
You can continue to contribute to your RRSP until the end of the year when you turn 71. At this time, you must close your RRSP account and either take out the cash as a lump-sum and/or transfer your RRSP into a Registered Retirement Income Fund or Annuity.
What this means is that at age 71, you must start using your RRSP funds as retirement income whether you like to or not.
RRSP Withdrawals To Purchase a Home
The Home Buyers’ Plan makes it possible for first-time homebuyers to withdraw up to $35,000 from their RRSP and put the monies towards the purchase or building of a qualifying home. A couple can combine resources and withdraw up to $70,000 ($35,000 each).
To participate in this program, you must complete Form T1036 and provide it to the financial institution where your RRSP account is held.
RRSP funds withdrawn under the HBP remain tax-free as long as you follow the rules for re-contributing them back. You must repay the amount withdrawn back to your RRSP within 15 years.
CRA provides an annual Home Buyers’ Plan statement of account that tells you the status of your repayments.
RRSP Withdrawals To Fund Your Education
If you own an RRSP account and are eligible, you can withdraw up to $10,000 per calendar year and up to $20,000 in total to finance your full-time education or training.
This program is known as the Lifelong Learning Plan (LLP) and you must complete Form RC96 and provide it to your RRSP issuer in order to utilize the LLP.
You have 10 years to pay back the amount you withdrew which means that you must repay at least 1/10th of the total amount you withdraw each year.
CRA sends you an LLP statement of account that shows how much you withdraw, your current balance and your next minimum repayment.
Read more about the LLP eligibility details here.
RRSP Withdrawals and Withholding Tax
The benefits of the Home Buyers’ Plan and Lifelong learning Plans are that: 1) They allow you to borrow money tax-free from your RRSP account, and, 2) You can re-contribute the amount you withdrew and continue to enjoy tax-sheltered growth on your retirement account.
When you withdraw funds from your RRSP outside of the HBP or LLP, your bank withholds tax and remits it to the government on your behalf. You also lose the contribution room permanently which means that you cannot re-contribute the amount you withdrew.
This tax that is withheld by your bank varies depending on the amount you withdraw and your province of residence.
RRSP withholding tax rates in Canada are:
- Withdrawals up to $5,000: 10% withholding tax (5% in Quebec)
- Withdrawals from $5,001 to $15,000: 20% withholding tax (10% in Quebec)
- Withdrawals exceeding $15,001: 30% withholding tax (15% in Quebec)
Quebec residents also have an additional 16% provincial sales tax withheld at source in addition to the federal tax rates shown above.
For non-residents of Canada, the flat withholding tax rate on any withdrawal is 25%. This rate may be less if your country of residence has a tax treaty with Canada. The taxes withheld by your bank may not account for all your tax obligations.
RRSP withdrawals are included in your total taxable income, and depending on your marginal tax rate, you may still owe taxes when you file your income tax return.
See the different tax brackets with combined federal and provincial tax rates here.
RRSP Withdrawals From a Spousal RRSP
Couples can manage their retirement income and taxes through the use of a spousal RRSP.
If you earn significantly more than your spouse (i.e. you are in a higher tax bracket), you can choose to contribute to a spousal RRSP.
The higher-income spouse claims the tax deduction at their higher marginal tax rate, while the lower-income spouse pays taxes at their lower tax rate when they make any withdrawals from the account. The family is able to lower their overall tax burden in retirement.
A few things to note when it comes to spousal RRSPs:
- You can only contribute to a spousal RRSP if you have contribution room.
- If the annuitant withdraws money from the RRSP account within 3 years of its contribution, the contributor (i.e. higher-income spouse) has to add the amount to their own taxable income and pay the taxes. This is referred to as the Spousal RRSP Attribution Rule.
- You can continue to contribute to a spousal RRSP even after you turn 71 if you have an RRSP contribution room and your spouse is under 71 years of age.
Should I Use My RRSP To Pay Off Debt?
It is generally not advisable. Here are the reasons:
1. You are raiding your retirement pot for the future. RRSP withdrawals outside of the HBP and LLP will result in a loss of contribution room. For example, if you take out $20,000 to pay off debt, that $20,000 contribution room is lost forever.
2. Taxes are withheld at the source. If you withdraw $20,000, a 30% withholding tax is levied which means you actually receive $14,000. And, you may still owe the CRA when you file your taxes in April because the amount you withdrew is added to your taxable income.
If you are trying to pay off a $20,000 debt using your RRSP, you will have to withdraw $28,571.
3. You lose out on compound tax-free growth. The funds you withdraw will result in fewer dollars working on your behalf. Compound interest and time are your best allies when it comes to investing for your future.
Every day that passes by with fewer dollars in your account and lost contribution room can be detrimental to your retirement plans.
As an example, a $20,000 RRSP balance earning 7% per year could easily grow to become $108,000+ in 25 years, even without making any further investments.
Depleting your RRSP should not be your first option when it comes to paying off debt. See if you can re-organize your finances and cut your expenses. Direct any extra cash towards paying off high-interest debt.
Find out if you can consolidate your debts into one and at a lower interest rate. A balance transfer credit card may come in handy when you are carrying credit card debt.
Find ways to earn extra cash. For example, find new or part-time work to increase your income, declutter and sell things you don’t need, or monetize your existing assets e.g. rent your car or unused room.
If you run out of options and have a TFSA, you can withdraw funds from there to pay off debt. The upside to using a TFSA to pay off debt is that you can re-contribute any amounts withdrawn in future years.
A scenario where withdrawing RRSP funds to pay off debt is less detrimental is when your taxable income is low. This could mean low to no taxes payable on the amount you withdraw.
Your bank will still withhold taxes, however, you can recover them at tax time. Note that this doesn’t change the fact that you lose that contribution room forever.
Your RRSP account belongs to you and you can choose to take money out at any time.
While funds remain in the account, they are tax-free. When you make a withdrawal, there are tax consequences depending on your overall taxable income. You also lose the RRSP contribution room.
Withdrawals relating to the Home Buyers’ Plan and Lifelong Learning Plan must be re-contributed within specific timeframes if you want to continue enjoying the tax-free benefits and growth that these RRSPs offer.