Should you take money out of your RRSP?

Whether or not to take money out of your RRSP for an important purchase may seem like a simple question. It’s your money, after all. But before exploring the answer, let’s agree on three things:

  1. The money in your RRSP is meant for your retirement. The “RS” in RRSP does in fact stand for “retirement savings.” Your RRSP isn’t supposed to be an emergency fund or lifestyle-enhancer.
  2. You’re free to reprioritize your life and money. No one will protect you from yourself if you raid your RRSP, cripple your financial future and ruin your retirement. That is, unless your RRSP is locked in, meaning the money in it used to be in a registered pension plan (e.g., with a former employer). In that case, there are ongoing restrictions on your access to it.
  3. This is what an RRSP “raid” looks like. It’s a lump-sum withdrawal before you retire, semi-retire or are forced to close your RRSP by the end of the year you turn 71.

When is a bad time to withdraw from an RRSP?

Here are some danger signs that you’re about to withdraw from your RRSP for the wrong reasons, putting your future financial security at risk:

  • You’re employed, have a home and are in good health. An RRSP withdrawal in those circumstances may indicate you’re not living within your means today.
  • It’s not a real emergency. You’d like to take a trip, build a home addition, pay for a fancy wedding, etc. But those aren’t emergencies.
  • You’ve done it before. The only thing worse than making a bad mistake is turning it into a bad habit.
  • You don’t understand the tax impact. Consider this scenario: You “need” $40,000 from your RRSP to buy a new car.
    • When you make a withdrawal of that size, your financial institution will set aside 30% in withholding tax, to pay to Canada Revenue Agency (CRA). So, you’d actually need to withdraw $57,142 from your RRSP to have $40,000 for the car.
    • The calculation is a little different in Quebec. Your financial institution will set aside 31% in withholding tax (15% for CRA, 16% for the province). So, you’d actually need to withdraw $57,971 from your RRSP to have $40,000 for the car.
    • The government isn’t finished with you yet. When you file your next tax return, CRA will recalculate your tax bill based on that extra taxable income. You may owe even more tax.
  • You don’t understand the hit on the future growth of your RRSP. Raiding your RRSP for a dollar today doesn’t mean you’ll have a dollar less to spend in retirement. If you’re decades away from retiring, each dollar you take out today could reduce the final tally in your RRSP by $5 or even $10.
  • You think your RRSP contribution room will be reinstated. Sorry, but with RRSPs, unlike tax-free savings accounts (TFSAs), you can use contribution room only once.
  • You’re looking to level out a variable income. If you’re a freelancer or earn commissions, an RRSP is the wrong account to use to smooth out your cash flow, because you’ll be eroding your RRSP contribution room for short-term needs. Instead, consider a TFSA or a regular savings account.
  • You’re making the decision without professional advice. A financial advisor can help you weigh the alternatives.

When is a good time to withdraw from your RRSP?

I’m not endorsing any of these scenarios, but there’s enough merit in them that it’s worth discussing with your financial advisor whether they’d be appropriate for you. I’m not aware of other scenarios in which it makes sense to even consider raiding your RRSP early.

1. You’re buying or building your first home

You can use the Home Buyers’ Plan (HBP) to withdraw up to $25,000 from your RRSP. Basically, you’re borrowing the money from yourself, interest-free -- but you have to repay it. CRA creates a repayment schedule for annual payments to your RRSP over a maximum of 15 years. Watch out, because there are penalties: If you miss a payment, that amount is added to your taxable income for that year. Otherwise, there are no tax considerations when you take the money out of your RRSP (i.e., there’s no withholding tax) or when you repay it.

Pros and cons. It’s generally a good thing to own your own home, though the Bank of Canada recently warned that Canadian homes are currently overpriced by up to 30%. Until you repay the money you withdraw from your RRSP, you’re losing out on the benefits of compound growth. The younger you are, the more you stand to lose. But the older you are, the scarier it is to raid your retirement savings, and the less time you have to make up for the loss in growth.

2. You’re returning to school

The Lifelong Learning Plan (LLP) allows you to withdraw up to $20,000 if you are or your spouse is returning to school full time. You must repay your RRSP over 10 years or less. Though there’s no interest charged or tax consequences if you make your payments on time, you will lose the benefits of compounding, and you will be dinged for tax if you miss a payment, as with the HBP; talk to an advisor before proceeding.

3. You’re taking a phased-in approach to retirement

Consider these two examples:

You’re 63 and you’ve cut back your hours at work. Though your employment income is reduced, you don’t want to start receiving your Canada/Quebec Pension Plan or employer pensions early at a reduced rate, and you’re too young to start receiving Old Age Security. Yes, you could convert your RRSP to a registered retirement income fund (RRIF) or a payout annuity -- and you will have to do that no later than the end of the year in which you turn 71, anyway. But you might not yet want the amount of ongoing income that RRIFs and annuities provide. Instead, if you’re looking for a bit of “bridge” income to supplement any employment income or personal savings you have, a lump-sum withdrawal from your RRSP might make sense.

You recently retired and you have no income. Your spouse is still working and you’re both living off of the one income. You could withdraw up to a certain amount from your RRSP without paying income tax on it (this is the Basic Personal Amount, the threshold at which income tax may start to apply; it’s adjusted every year). Note that your financial institution would hold back 20% withholding tax (26% in Quebec) for that size of withdrawal, but since you have no other income, the withholding tax would be returned to you when you file your taxes. This technique would probably save you tax, compared with waiting until later to take the money from your RRIF.

Pros and cons. Consult a financial advisor, because this is intricate stuff. For example: Lump-sum withdrawals from RRSPs don’t qualify for the $2,000 Pension Income Tax Credit, but annuity income from an RRSP does qualify if you’re 65 or over; you may be choosing between the lump sum now and the tax credit later. RRIF income also qualifies for the tax credit, but only if you’re 65 or over. If you’re under 65, lump-sum withdrawals from an RRSP receive the same tax treatment as RRIF, annuity or employment income.

As for me, before I begin to receive Canada Pension Plan or employer pension payments, or convert my RRSP to an RRIF, I’ll be talking with my advisor about whether it makes sense for me to make a lump-sum withdrawal from my RRSP.

4. Your health is a major concern

If you don’t expect to reach retirement age and you don’t have a spouse who is the beneficiary of your RRSP (a spouse named as RRSP beneficiary can receive the entire RRSP balance without paying tax), talk to your family and your financial advisor about your wishes and your options.