Maybe you’re facing a layoff or feeling the effects ofmarket volatility. Maybe you have higher expenses due tohigh inflation. And maybe you’re eyeing your savings as a possible source of emergency funds.
Whatever the situation, you may be wondering if it’s ever smart to make early withdrawals from a registered retirement savings plan (RRSP). In most cases, the answer is no.
Here are three hidden costs of making an early RRSP withdrawal.
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 compound interest.
When you take money out of your RRSP early, you lose the opportunity to earn money while it’s invested.
Remember, the government will not tax you 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 RRSP withholding tax. The amount you pay depends on the amount you withdraw and where you live.
- Taking$5,000,meansthe withholding tax rate is 10%.
- Withdrawingbetween $5,001 and $15,000meansthe withholding tax rate is 20%.
- Removingmore than $15,000meansthe withholding tax rate rises to 30%.
Note 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.
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.
Withdrawals from a spousal RRSPcan also carry additional risks. Let’s say you’re making ongoing contributions to a spousal RRSP and your spouse withdraws funds. If there has not been a spousal contribution in the last three years, then attribution rules do not apply. 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. It’s best to check with an advisor before making a withdrawal to see how it may affect you.They can help you manage your finances and make the most of your investments.
3.You’ll permanently lose RRSP contribution room
You can put only so much into your RRSP. And once you take money out, you can’t replace the amount you had previously put into your plan. This reduces the potential value of your RRSP when you’re ready to retire.
This article is meant to provide general information only. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.
FAQs
You'll miss out on the advantages of compound interest
Why is it unwise to withdraw money from an RRSP before retirement? ›
RRSP withdrawals at age 55
Plus, the withdrawal increases your taxable income for the year, which could bump you into a higher tax bracket. And the money you withdraw reduces your RRSP contribution room, which limits your future retirement savings potential.
What happens if you withdraw $20000 from your RRSP? ›
As long as your RRSP isn't a locked-in plan, you can take money out of your RRSP any time. However, any amount you withdraw will be included as income for tax purposes. You'll also pay withholding tax on the amount you withdraw (based on the amount of the withdrawal).
Should I withdraw money from my RRSP before I turn 71? ›
Making early, strategic withdrawals from your RRSP makes sense in this situation because it can: Lower taxes that you pay in the long term. Spread out your RRSP/RRIF withdrawals over more years. It can provide a source of cash flow before you start collecting other forms of income like pension income or CPP and OAS.
What happens to my RRSP if I move out of Canada? ›
Canadian citizens that have become non-residents can continue to hold RRSPs after leaving Canada.
What are the disadvantages of RRSP withdrawal? ›
What happens when you withdraw money from your RRSP early?
- You'll miss out on the advantages of compound interest. An RRSP works best with long-term, steady contributions. ...
- You'll have to pay tax on your RRSP withdrawals. ...
- You'll permanently lose RRSP contribution room.
There are two ways: first is by using the funds for education through the Lifelong Learning Plan. Second is by purchasing a house under the Home Buyer's Plan. With these two programs, no withholding tax is required. Also, the withdrawal of your RRSP fund will not be considered as income.
What is the 4% rule for RRSP? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
Does taking money out of RRSP count as income? ›
Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan. However, you generally have to pay tax when you cash in, make withdrawals, or receive payments from the plan.
Is it worth it to withdraw from RRSP? ›
You will pay income tax : the amount withdrawn from your RRSP could move you into a higher tax bracket. You could jeopardize your retirement : by withdrawing funds from your RRSP before retirement, you're only postponing your debt problems.
Going a step further, calculations should be made to determine if you should withdraw funds from an RRSP. In many cases, we will recommend that people convert their RRSP to a RRIF before age 71. Age 64 or 65 are common ages for conversions to a RRIF, which we will explain below.
What happens to my RRSP when I turn 72? ›
An RRSP must mature by December 31 of the year in which you turn 71. On maturity, the funds must be withdrawn, transferred to a RRIF or used to purchase an annuity. You will not be able to make any further contributions to your individual RRSP after this date.
What should I do with my RRSP at age 70? ›
You can convert your RRSP holdings to a RRIF at any time. However, an RRSP must be converted to a RRIF or annuity, or paid out in a lump sum by the end of the calendar year in which you turn age 71.
Can I move my RRSP to the USA? ›
Expert Answer: The U.S. equivalent of an RRSP is known as an Individual Retirement Account (IRA). Unfortunately, RRSP assets cannot be rolled over to a U.S. IRA. If you withdraw funds from your RRSP, the entire amount of the withdrawal is subject to Canadian withholding tax.
What to do with RRSP when you move to USA? ›
Canadian citizens who live and work in the United States may contribute to an RRSP as long as they keep within the contribution threshold. Canadians may keep their RRSP intact when they move to the United States and let the income grow tax-deferred for Canadian tax purposes.
Can I transfer my RRSP to my bank account? ›
Our response: You are able to transfer an RRSP to a different financial institution by authorizing the transfer of your funds. You can initiate the transfer through the receiving financial institution. One or both of the financial institutions involved may charge you a transfer fee.
Can I use my RRSP for early retirement? ›
Yes. You can submit a request to redeem your RRSP from the time you turn 45 years of age, if you meet certain conditions. To redeem your RRSP+ starting at 45 years of age, you must have taken or be set to take early retirement under your employer's registered pension plan within three months of the request.
When should I not use RRSP? ›
Seven reasons to reconsider contributing to your RRSP this tax season
- If you don't already have an emergency fund or other investments that are liquid. ...
- If you make roughly $100,000 or less. ...
- If you plan to just spend the extra money from your RRSP refund. ...
- If you have unpaid debt.
Once you retire, you have three options: Cash out all your savings as a lump sum (income taxes will apply) Convert your RRSP to a Registered Retirement Income Fund (RRIF) Purchase a Life Income Fund (LIF)
Can early RRSP withdrawals bring advantages? ›
Making extra RRSP withdrawals in low-income years can result in tax savings. Under certain circ*mstances, those who take strategic early withdrawals from a registered retirement savings plan may find tax and other financial advantages, experts say.
