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finance february

There are ways to tap your RRSP sooner. You just have to be careful how you go about it.Peter Power/The Globe and Mail

Every year at this time we're bombarded with reminders to put money into our RRSPs. But what if you want to get some of that money out?

The usual way to access RRSP funds is wait until you're retired, convert your registered retirement savings plan into a registered retirement income fund (something you must do by Dec. 31 of the year you turn 71) and start making withdrawals according to government-mandated minimums.

But for those who can't wait that long, there are ways to tap your RRSP sooner. You just have to be careful how you go about it.

"There are only a couple of scenarios where it makes sense, maybe three scenarios," says Jamie Golombek, managing director, tax and estate planning, with CIBC Private Wealth Management.

One option is to take advantage of the Home Buyers' Plan (HBP), a federal program that allows first-time home buyers to withdraw up to $25,000 from their RRSPs to purchase or build a principal residence.

Generally, you must repay the money to your RRSP over a period of no more than 15 years. If you fail to make the annual minimum repayment, it will be added to your income for the year and taxed, so there is a strong incentive to repay the funds.

The downside of the HBP is that you're shifting money – at least temporarily – from your retirement nest egg to the purchase of a house. The upside is that you will have a larger down payment and lower interest costs, and you'll potentially avoid mortgage insurance if you can put down at least 20 per cent of the purchase price.

A second way to access funds from your RRSP is through the federal Lifelong Learning Plan (LLP), which allows you to withdraw up to $20,000 – with an annual limit of $10,000 – to pay for full-time education or training for yourself or your spouse. Generally, you are required to repay the money to your RRSP over a 10-year period. As with the HBP, any amounts that are not repaid when due are added your income and subject to tax.

The big advantage of both the HBP and LLP is that the withdrawals are not added to your income – assuming you make the required repayments – and there is no tax withheld on the money.

RRSP withdrawals for other purposes are subject to tax, however, which is why most people are reluctant to dip into their RRSPs unless they have no other options.

"There is this sort of psychological fence around the RRSP where people are very reluctant to touch it," Mr. Golombek says. "Most people do it out of desperation because there's an emergency. They need access to cash because of a medical emergency or because the roof is leaking and they have no funds set aside."

Such withdrawals come with a price, however. First, that RRSP contribution room is lost, so you couldn't recontribute the funds unless you had additional room available. Second, the withdrawal is added to the RRSP holder's taxable income, and the Canada Revenue Agency requires financial institutions to withhold a portion of the funds as a prepayment of the person's eventual tax bill.

The amount of tax withheld depends on the size of the withdrawal. The rate is 10 per cent for amounts up to $5,000, 20 per cent for amounts of more than $5,000 up to and including $15,000, and 30 per cent for amounts over $15,000. (Note: A person could end up owing even more tax at the end of the year, or getting a refund, depending on their other sources of income.)

That's not to say you should never consider withdrawing funds early from your RRSP. If you find yourself in a very low tax bracket one year – say you lost your job or decided to take parental leave – it can make sense to withdraw RRSP funds, because the tax hit will be much smaller than during years when your income was higher.

Jason Heath, a fee-only financial planner with Objective Financial Partners in Toronto, has a client in her mid-50s who runs a daycare in Ontario. With the province phasing in full-day kindergarten, the client expects that her income will decline dramatically over the next few years, to the point that she is considering early retirement.

After running some numbers, Mr. Heath concluded that it would be beneficial for the client to start slowly drawing down her RRSP while still in her 50s rather than wait until she turns 71. Because her income will be higher later on, as a result of Old Age Security and the Canada Pension Plan, her RRSP withdrawals would be taxed more heavily and could also cut into income-tested benefits and credits.

"From a tax perspective it sometimes makes sense to take out RRSP money early because over the long run you might be in a better tax situation," Mr. Heath says.

While early RRSP withdrawals can be beneficial as part of the HBP and LLP, people in other circumstances need to think carefully about the ramifications, Mr. Golombek says.

"My general advice is don't do it unless you absolutely need the money, or you're in a situation where … your income that year is particularly low," he says.