Most Canadians spend their working lives socking away as much money as they can in their registered retirement savings plans (RRSPs) — often feeling guilty if they’re not maxing out the contribution limits set by the federal government.
Once retirement rolls around, it’s time to switch gears and start planning how to use those RRSP funds to help replace employment income. There are clear rules about when you have to wind down your RRSP, which is by Dec. 31 of the year in which you turn age 71, either withdrawing the funds or converting them into a registered retirement income fund (RRIF) or a registered annuity.
Still, experts say there are some situations where it makes sense to make some early withdrawals from your RRSP.
First, investors should clearly understand what an RRSP is — a tax deferral account — says Jason Pereira, a partner and financial planner at Woodgate Financial in Toronto, which can be used to your advantage.
“There is a tax bill due at some point,” he says. “You have a ‘partner’ in your RRSP – the Canada Revenue Agency. The share your partner will get depends on your decisions. It can make sense to pay 20 cents on the dollar in tax today versus 50 cents tomorrow.”
The pre-retirement case for pulling RRSP money out early
The main reason to pull money from an RRSP early is to take advantage of two government programs that offer tax-free RRSP withdrawals: The Home Buyer Plan (HBP) and the Life-Long Learning Plan (LLP).
The HBP allows you to withdraw up to $35,000 tax-free, to help make a down payment on a first home, or for those who haven’t owned a property within the last four years. Couples, either legally married or common-law, can withdraw up to $35,000 each for a total of $70,000 towards the same home purchase. You then have 15 years to repay the borrowed amount back into your RRSP, with the first payment due two years after the withdrawal.
With the LLP, you can make tax-free RRSP withdrawals to pay expenses for a return to full-time education or training. You have up to 10 years to repay your RRSPs under the LLP.
Once you get into your retirement years, most circumstances where making early RRSP withdrawals might make sense are related to minimizing tax.
“The idea has always been to contribute to an RRSP in high-earning years to get the income tax deduction, and then withdraw or take RRIF income in lower income years,” says Carol Bezaire, vice-president of tax, estate and strategic philanthropy at Mackenzie Investments in Toronto.
Minimize a tax hit
A specific reason to make early withdrawals from an RRSP is to minimize an individual’s overall lifetime tax hit. This is often the case where a person retires at age 65, or sooner.
If they have a large RRSP, the amount they will be required to be drawing from their RRIF once they hit age 72 — a set percentage that increases each year — could put them in a bracket where they are paying a substantial amount of tax. However, if some of that RRSP is withdrawn between ages 65 and 71, the tax rate may be significantly lower.
A related situation occurs when individuals decide to defer their Canada Pension Plan (CPP) and Old Age Security (OAS) payments until after age 65, says Jason Heath, managing director at Objective Financial Partners in Markham, Ont.
For those with little or no defined-benefit pension income, starting RRSP withdrawals early and deferring CPP and OAS pensions to age 70 “can be really advantageous,” Mr. Heath says.
He notes the amount an individual receives from the government increases with each year of deferral: 8.4 per cent after age 65 for CPP and 7.2 per cent for OAS, plus inflation.
“Deferring these pensions provides longevity protection if you live a long life,” Mr. Heath says. “It also makes retirement income planning easier as you age.”
Support cost of living
The cost of living in retirement may also require people to make occasional withdrawals from their RRSPs.
Ms. Bezaire of Mackenzie says many Canadians have saved money in their RRSPs but have not maximized their tax-free savings account or other savings like non-registered investments.
Once people start receiving their government retirement benefits but have yet to convert their RRSP to a RRIF, she says they may find it necessary to access their RRSP savings to fund their day-to-day expenses.
They can convert their RRSP to a RRIF at that point and begin taking systematic withdrawals or make occasional lump sum withdrawals when needed.
Ms. Bezaire points out there is tax withheld on lump-sum RRSP withdrawals and the withdrawal is taxed as income, whereas a RRIF minimum payment doesn’t have withholding tax but it is taxable as income.
Some people also use their RRSP to cover large, unexpected expenses, such as helping a family member make a down payment on a house.
While an early RRSP withdrawal may make sense in this case, most advisors recommend looking for other ways to cover it, such as using a line of credit or other types of debt. Using the RRSP will have tax implications and can have a significant impact on retirement plans.
“An RRSP is there to set yourself up for life, and minimize tax,” Mr. Pereira of Woodgate Financial says. “Doing one can help you with the other.”
Any decision to make an early RRSP withdrawal should be considered as part of an overall retirement plan, Mr. Pereira says.
“The only way to know for sure is to have a comprehensive financial plan,” he says. “That’s how you make smart decisions when it comes to tax and retirement security.”