What happens when you withdraw money from your RRSP early?
Early withdrawals from RRSPs have three major costs:
1. You’ll miss out on the advantages of compound interest
An RRSP works best with long-term, steady contributions. That way, your savings grow because the interest you earn also earns interest. The interest on that interest earns interest, and so on. This is called compounding.
When you take money out of your RRSP early, you lose the opportunity to earn money while it's invested.
Remember, you’re not taxed on money growing in your RRSP until you take it out.
2. You'll have to pay tax on your RRSP withdrawals
If you take money from your RRSP, the government will charge a withholding tax. The amount you pay depends on the amount you withdraw and where you live.
- Taking $5,000, means the withholding tax rate is 10%.
- Withdrawing between $5,001 and $15,000 means the withholding tax rate is 20%.
- Removing more than $15,000 means the withholding tax rate rises to 30%.
Note that these tax rates apply everywhere in Canada except Quebec. In Quebec, the federal rates are lower, but provincial tax rates apply in addition to the federal withdrawal rate.
But the taxes don’t end there. Your taxable income will include the RRSP withdrawal for the year. So if your marginal tax rate* is higher than the withholding tax rate, you’ll pay extra on your withdrawal.
(*The marginal tax rate is the amount of additional tax paid for every additional dollar earned as income.)
And withdrawals from a spousal RRSP can carry additional risks as well. Let’s say you’re making ongoing contributions to a spousal RRSP and your spouse withdraws funds. Depending on the timing, all or a portion of the withdrawal will be included in your taxable income and not your spouse’s. This may result in an additional tax implication if you’re in a higher tax bracket than your spouse. So, it’s best to check with an advisor before making a withdrawal, to see how it may affect you.