The hidden costs of early RRSP withdrawals (video)

The hidden costs of early RRSP withdrawals (video)

The COVID-19 pandemic has led some Canadians to consider dipping into their savings. But is it smart to make early withdrawals from a registered retirement savings plan (RRSP)? In most cases, the answer is no.

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 called compounding.

2. You’ll have to pay tax on your RRSP withdrawals

If you take money from your RRSP, the government will charge a withholding tax. The amount you pay depends on on the amount you withdraw and where you live.

  • Taking $5,000, means the withholding tax rate is 10%.
  • Withdrawing between $5,001 and $15,000 means the withholding tax rate is 20%.
  • Removing more than $15,000 means the withholding tax rate rises to 30%.

Note that these tax rates apply everywhere in Canada except Quebec. In Quebec, the federal rates are lower, but provincial tax paydayloanstennessee.com/cities/jellico/ rates apply in addition to the federal withdrawal rate.

But 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.

And withdrawals from a spousal RRSP can carry additional risks as well. Let’s say you’re making ongoing contributions to a spousal RRSP and your spouse withdraws funds. Depending on the timing, 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. So, it’s best to check with an advisor before making a withdrawal, to see how it may affect you.

3. You’ll permanently lose RRSP contribution room

You can only put so much into your RRSP. So, once you take money out, you can’t replace the amount you had previously put into your registered savings plan. This reduces the potential value of your RRSP when you’re ready to retire.

What can you do if you need emergency funds?

Simply put, experts advise not to take money from your RRSP before you retire. It’s best to explore other options before you touch your RRSP.

  • You can take money out of your tax-free savings account (TFSA). A TFSA is a good place to keep an emergency fund. Why? Because you can put back any money you take out the following year. (But be sure to repay your TFSA promptly, to minimize the loss of investment growth.)
  • You can withdraw funds from non-registered assets. This might include guaranteed investment certificates (GICs), segregated funds or savings bonds. If you have these assets, consider using them before touching your RRSP. Unlike withdrawing funds from an RRSP, withdrawing funds from these investments won’t increase your taxable income. (Although, you’ll give up the potential investment earnings).
  • Had you planned to use these funds for retirement? Then you may have to adjust your retirement savings plan. Make some tweaks to ensure that you’ll still have enough funds to afford the lifestyle you want.
  • Do you want to know how much you’ll need to save for retirement? Try our Retirement savings calculator.
  • Has a financial emergency left you looking for an ongoing source of cash? If so, start by re-evaluating your budget and temporarily reducing expenses you don’t need. For example, has the pandemic left you working from home or kept you from social events? Then you’re probably saving money you may have previously spent on commuting or entertainment.
  • Wondering where your money goes? Use our monthly budget calculator to find out.