Before making an early withdrawal from an RRSP — for any reason — you should understand your tax situation, say financial experts.
The No. 1 reason for determining whether people should take money out of their RRSP before retirement is their marginal tax rate, said York University finance professor Moshe Milevsky.
Is it 15 per cent, 30 per cent or 50 per cent?
In the years in which your income is low, you can take advantage of that and pull some money out of the RRSP at a low tax rate, he said.
But withdrawing the money doesn’t mean spending it, Milevsky added.
“I am not advocating taking that money and going to Bermuda.”
He recommends putting that Registered Retirement Savings Plan money in a Tax Free Savings Account, or a “tax efficient” investment.
When you’re in a high income tax bracket, make the RRSP contribution and take the deduction, said Milevsky, who teaches at York’s Schulich School of Business.
“So the RRSP is sort of a thermostat which you use depending on the economic environment and what your income is at.”
When else might you consider an early RRSP withdrawal?
BMO’s Marlena Pospiech said it’s also a possibility for those leaving the workforce for a period of time, such as women staying home with children.
“If it’s withdrawn during the low income earning years, you pay less tax on it than when you’re going to be working and your income shoots up and your marginal tax rate goes up,” said Pospiech, senior manager BMO Wealth Planning Group.
What about using an RRSP withdrawal to pay debt?
Financial writer Gail Vaz-Oxlade said she gets that question a lot.
“The only time it makes sense to do that is if you are not working,” she said.
“You have no income and you are in the lowest possible tax bracket, then it’s not the worst thing in the world,” said Vaz-Oxlade, author of the book “Money Rules” and TV host of “Princess” and “Til Debt do Us Part.”
Vaz-Oxlade said you’re not helping your retirement, but your tax position won’t be any worse.
“If you are working — absolutely not,” she said.
BMO’s Pospiech said taking money out of an RRSP to pay down debt would be a last resort for a “more desperate situation.”
“I would think that indicates there is potentially an issue with overspending based on income. That’s more of a credit discussion and how you’re using credit,” she said.
Milevsky said using an RRSP to pay down debt depends, again, on an individual’s marginal tax rate.
“In a high bracket, that deduction is really, really valuable. Maybe don’t pay down your debt. On the other hand, if you’re in a low bracket and your debts are ticking along at four, five, six per cent and your RRSP isn’t going to earn that much on a steady basis, then pay down the debt.”
People can use online calculators and visit Revenue Canada or Statistic Canada’s websites to figure out what tax bracket they’re in, he said.
What about using the RRSP in the case of job loss?
If you’re getting a severance, it might not be wise to do so right away, said Pospiech.
“That RRSP withdrawal will be subject to a higher marginal tax rate than if you wait until the year following the job loss,” she said.
And on thinking ahead to when you will have to collapse your RRSP at 71?
Milevsky also said those approaching retirement may want to pull some money out of an RRSP to put into a TFSA if they believe their various sources of retirement income, including company and government pensions, could push them into a higher bracket when retired.
“You really have to think backwards from retirement. I think that’s the key.”
The deadline for this year’s RRSP contribution is March 1.
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