A Registered Retirement Savings Plan (RRSP) is a Canadian retirement saving that services employees and self – employed citizens.
Normally, an amount is put into an RRSP and this grows, free of tax until withdrawal is made and then it is taxed at the marginal rate. Also note that having money in an RRSP is never an assurance of a comfortable retirement, it is only an assurance that the funds will compound, tax-free, for as long as they are not withdrawn.
Again, the benefits of savings cannot be emphasized, especially in this part of the world. We have the singular responsibility to structure or incomes to make sure a substantial amount is kept for retirement.
How Much Savings Do You Have To Cater For Spontaneous Needs and Emergencies?
I’m certain that you have most likely heard the phrase “… save for the future” but it is somewhat unlikely for you to have heard “…save for retirement”. You may observe some old fellows in your neighbourhood and think to yourself that they are doing really well because they have kids that are well to do.
While that may be true, there is also the possibility that they had (or might still have) a savings plan while they were much younger. One which they followed strictly and to whose rules they abided.
Types Of Registered Retirement Savings Plan (RRSP)
RRSPs are established by one or two individuals that are either associates or related in any way- spouses inclusive.
There are quite a number of RRSPs that you probably might have heard of but below are a few of them:
1. Individual RRSP: This type is created by a single individual who acts as both the account holder /operator and the funder.
2. Spousal (or couple) RRSP: This type makes provision for a single spouse and tax benefit for both spouses. The spouse who earns more income (usually called a high earner) is regarded as the spousal contributor as he/she contributes funds in the RRSP in the name of their spouse (the account holder). The retirement income is, of course, shared equally, enabling a lower marginal tax rate.
3. Group (or team) RRSP: This type of retirement plan works a bit differently from the first two in that it is established by an employer on behalf of his employees. The investment in this account is majorly payroll deductions and could also constitute of incentives and income arrears. It is operated by an investment manager and gives the contributors the benefit of tax saving.
4. Pooled RRSP: This type is not very common but it is another efficient type of RRSP. This option came to light for the good of SMEs. Now, small business employees, employers and self-employed Canadians can adequately plan for retirement.
You would agree with me that the accumulation of consistent incoming funds, no matter how little, over a period of time can result in a massive yield in investment.
In lieu of this, these savings plans do not only yield much when you invest for a long period of time, they also bring about heavy returns if withdrawals are not made on the account. But what happens when early withdrawals are made?
Penalties Of Early Withdrawals From Your RRSP
Tax is paid on withdrawal: I know I mentioned earlier that the funds in RRSP are tax-free but it might interest you to know that upon withdrawal from your RRSP, you would incur charges from withholding tax which could have easily been avoided, had you not withdrawn. Withdrawals that are up to $5,000 attracts a withholding tax rate of 10%.
Withdrawals between $5,001 and $15,000 attracts a withholding tax rate of 20%. Finally, withdrawals that are more than $15,000 attracts a withholding tax rate of 30%. In areas where provincial tax rates apply above the federal withholding tax.
For example in Quebec, these tax rates do not apply. Of course, you should know that when you withdraw cash from your RRSP, you would have to declare the full amount as earnings in the withdrawal year and this policy would attract a weighty tax bill.
The consequences are higher for withdrawals from a spousal RRSP. This is because if you are making a contribution into the account and your spouse withdraws funds, 100% (or maybe less) of the withdrawal will be added to your taxable income instead of your partner. This would ultimately cause more expenses and tax implications for your family.
I recommend that you clearly communicate these consequences with your spouse and you both agree to refrain from withdrawals. If it is an emergency and withdrawal is unavoidable check with your financial advisor before making a withdrawal.
Forfeiture Of Tax-Sheltered Compounding
One of the advantages of RRSP in the first place is to ward off the compounding of tax on earnings. Of what use then is the saving plan when the real purpose is defeated?
When you withdraw early from your RRSP, no matter how little, because of the effect of accumulation, you might end up having way less the amount you should have had if you hadn’t made the withdrawal.
RRSP Vs. TFSA
So if you need emergency funds at any time, I would advise you to take money out of your tax-free savings account (TSFA). This is a relatively flexible account, in that you can return any money you take out in the nearest future.
Forfeiture of contribution home: How would you like to lose the contribution room with which you have always been using to make your deposit? Cruel, right?
Well, this is what happens when you make a withdrawal from your RRSP. You not only lose it permanently but you also would not be allowed to re-contribute the same amount you withdrew. Even though you can still make your maximum contribution in the future, it would never make up for the loss in the value of your investment at retirement.
So like I said earlier, if you really need to make an emergency withdrawal, there are a couple of other account that you can access without consequences.
One of them is your TSFA and others include investments like guaranteed investment certificates (GICs), savings bonds and segregates funds. These options should be explored first before even considering your RRSP because withdrawing funds from them would not increase your taxable income, you might just risk losing the potential investment earnings.
How To Withdraw From RRSP and Avoid Tax Penalties?
You know how there are two sides to every coin, right? Well, there are two sides to these policies too! You can actually withdraw from your RRSP whenever you want to without incurring any tax penalties. Did you say how? Here is how:
1. Get that home: This way out is commonly called The Home Buyers’ Plan (HBP). If you and your spouse have not owed a home in the past 5 years, this might just be a way out for you from the tax penalties that come with withdrawing from your RRSP. This plan allows you and your spouse to withdraw as much as $25,000 from each of your RRSPs to either buy or build a home. Kindly note that this withdrawal is more like a loan because you are both expected to pay back the amount within 15 years. Good thing is that there is no interest payment on this amount.
2. Get that education: For some of you, education is one of the last things on your mind. Your high school degree and/or your college degree is just about all you need to have. While for some others, all you need is adequate finance to get back to the school or even to attend training. Whatever category you fall into doesn’t really matter.
What Is The Lifelong Learning Plan (LLP)
All that matters now is that you can make withdrawals from your RRSP for a purpose known as The Lifelong Learning Plan (LLP).
This plan allows you to make withdrawals up to $10,000 each year for 4 years to fund your education or training expense or that of your spouse or even your common-law partner.
Again, this money cannot be used to fund your own child and the total amount must not exceed $20,000 payable in full within 10 years.
You will receive an LLP notification from CRA each year with your LLP balance, payment that has been made and the amount of your next LLP payment.
Reserves that are taken out from your RRSP under the House Buyers’ Plan (HBP) or the Lifelong Learning Plan (LLP) are legally not taxable as long as the amounts are paid back in record time. The only disadvantage here is the loss of several years of tax-sheltered compounded increment on your retirement savings as you make efforts to pay back the amount. So the quicker you can pay back, the less growth you will lose.
Locked-in RRSP withdrawal
The easiest way to avoid unnecessary withdrawal from your RRSP is by locking-in the funds. These locked-in funds would not be unlocked until you get to a certain age. This age scale is to be determined by you, although most people use 71.
All locked-in funds will only be unlocked (not in all provinces) on the basis of severe financial hardships or shortened life span.
There you go, that was the detailed guide to the Canadian RRSP withdrawal and how it works.
I’ve written a ton of articles about RRSP on this blog comparing RRSP vs TFSA, RRSP In general, Canadian Taxes and so on. Do check them out if you want to learn more or anything in specific.
If you found this article helpful do share it on social media and help spread the word. Also, for any questions or suggestions you may have please let me know in the comments below. Have a fantastic day!
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Sagar Sridhar is a personal finance blogger from Canada. His genuine passion for personal finance coupled with his unique style of writing is what stands out. Professionally, he is a computer engineer, agile certified and has a master’s degree in Project Management. His writing has been featured or quoted in the leading Canadian publications such as Credit Canada and many other personal finance publications. While he is juggling between his day job and blogging, he is the main author on this blog and has miles to go before making the final pit stop.