For most Canadians, an RRSP (or Registered Retirement Savings Plan) is a wise part of any retirement savings strategy. Any money deposited to this special type of savings account can be used to buy securities (stocks, bonds, mutual funds, GIC’s and more) and grow without being subject to income tax until the funds are withdrawn. This would typically begin at retirement when one’s income is substantially lower and would therefore have a lower income tax rate. The idea is that until retirement the money inside the plan would grow much faster when one doesn’t have to worry about taking any tax off the top from year to year.
But what happens if someone wants to use that money before they retire?
Ideally, investors should be very cautious if they are considering removing any funds from their plan before retirement. However, sometimes investors may encounter unforeseen situations such as unemployment, disability, or other emergencies that will require an infusion of cash. If that is the case, then taking funds out of the plan may be necessary.
RRSP Withdrawals are Subject to Withholding Tax
The first thing that every investor should know is that RRSP withdrawals are subject to a withholding tax. A withholding tax is a percentage of your gross withdrawal (meaning the total dollar amount that is being taken out of the plan), that will be held back by your financial institution. For all the provinces of Canada (except Quebec) the amount withheld is as follows: up to $5,000.00 is 10%, $5,000.01 to $15,000.00 is 20%, and over $15,000.00 is 30%. In Quebec, the rates that result from a combination of federal and provincial tax are equal to 21%, 26% and 31% accordingly.
A withholding tax exists because any funds that were put in to the plan are done so before income tax has been applied. Since those funds are now being taken out, they are considered income and are now taxable. The withholding tax will be applied as tax paid on the money withdrawn, but depending on your tax bracket, there still may be additional funds owed at the end of the year.
Two exceptions to this are the Home Buyers Plan and the Life Long Learning Plan. Both of these plans allow for a limited tax free withdrawal from your RRSP as long as you repay the money in to your plan over a pre-determined period of time.
Lost Earning Potential on RRSP Withdrawals
In addition to withholding taxes, investors should also keep in mind that they will be losing a great deal of earning potential when funds are taken out of the savings plan early. For every dollar taken out prior to retirement age, the earning potential in the RRSP is greatly diminished. The less available in the plan, the slower it will grow.
It should also be noted that there may be certain restrictions on some of the investments held in a registered plan that may prevent them from being sold and the cash equivalent being withdrawn (a GIC that has not come to maturity would be a good example of this). This should be factored into any decision before an investor considers making a withdrawal.
Moving Money Between RRSP Accounts
Many investors may have more than one RRSP, either with the same financial institution or a different one. As long as the funds or securities are eligible to be transferred from one account to another, and are going from one RRSP to another, a withholding tax would not apply. However one should be aware that there may be fees charged by a financial institution to do so.
Anyone considering withdrawing funds from their RRSP should first discuss the risks and benefits with their investment advisor or a certified financial planner