Withdrawing from your RRSP
You have been diligently saving for your retirement in your Registered Retirement Savings Plan (RRSP). However, after surveying your finances, needs, and opportunities, you decide that you need to withdraw some money from your RRSP.
The RRSP is, as the name indicates, a savings plan. You put money into an RRSP while you are earning an income. In exchange, you get a tax deduction for the contributed amount, and your assets in the account grow on a tax-deferred basis as long as they remain inside the account. At the end of your working career, you can: 1. Withdraw the entire amount and pay tax on it – this is almost always a bad idea; 2. Use the accumulated amount to purchase an annuity from an insurance company; and/or 3. Open a Registered Retirement Income Fund (RRIF) and transfer your RRSP savings into the new account, from which you receive income from those accumulated assets. While you were contributing to your RRSP you received tax deductions and benefited from tax deferrals. Now, the deferred taxes come due, but only on the amounts you withdraw each year.
Tax-Free Withdrawals: Two Options
There are two programs the government has provided that allow you to withdraw money from your RRSP without having to pay tax on the withdrawals. Note that any withdrawals must be made from funds that have been in the RRSP for at least 90 days.
Lifelong Learning Plan (LLP)
Let’s imagine you worked in a job for several years. However, the opportunities in your industry are declining. You see the “writing on the wall” and believe you have no choice but to go back to school to retrain for a new career.
Enter the Lifelong Learning Plan (LLP). This program is designed to allow you to attend school and use the funds in your RRSP to help you with your costs. You can withdraw up to $10,000 each year and up to $20,000 in total. If you are married, your spouse can also do the same to help fund your education. You do not need to use the funds specifically for tuition or other fees charged by the qualifying educational institution. If you meet the requirements to draw on the LLP, you can use the funds for any purpose.
Funds withdrawn from your RRSP under the LLP must be paid back over 10 years. Let’s imagine that you went to a four-year university program from which you graduated in the spring of 2021. In the summer before each of those four years – 2017, 2018, 2019, and 2020, you withdrew $5,000. You must begin paying your LLP back in the earlier of the fifth year following your first withdrawal, so 2022 in this case, or the year after the first year that you were not considered a full-time student for at least three months of the year, which would be 2023. If this sounds confusing, the Canada Revenue Agency has a simple questionnaire here that helps you understand when your repayment obligations start.
In 2022, therefore, you must begin paying back at least $2,000 per year for the next 10 years. You can choose to accelerate those payments into your RRSP if you wish or make contributions to your RRSP of which $2,000 is designated as an LLP repayment and the remainder is a new contribution.
If you fail to repay the required $2,000 in any given year, that amount becomes taxable income to you.
The term “lifelong” is important to consider. If you have fully paid back an earlier LLP withdrawal but wish to do some qualifying education once again, you are free to make use of the LLP a second (or third, fourth, etc.) time.
Home Buyers’ Plan (HBP)
The Home Buyers’ Plan (HBP) allows you to withdraw up to $35,000 from your RRSP to purchase a qualifying home. In the case of a married or common-law couple, that means you have up to $70,000 of RRSP assets at your disposal without immediate tax consequences from a qualifying withdrawal.
Note that to qualify, you cannot have owned a home in the year you wish to use the HBP or in the previous four years.
You must pay back funds withdrawn from your RRSP under the HBP over 15 years. Your repayment must begin the second year after the year when you first withdrew the funds from your RRSP. If you withdrew funds to purchase a home this year, in 2021, your first repayment must be in 2023. As with the LLP, you can simultaneously contribute new money to your RRSP and designate the portion that makes up the required minimum as an HBP repayment. If you fail to make a required minimum payment, to the extent you fall short in any given year, that shortfall will be recognized as taxable income to you. $35,000 divided into 15 years equals $2,333.33 per year.
You may have other reasons to withdraw from your RRSP that have nothing to do with a home purchase or going back to school. Nothing stops you from taking money out of your RRSP for any reason you wish as long as you are prepared to pay the tax.
For example, let’s suppose that you have had a baby and plan to take your full allotment of 15 weeks of maternity benefits plus 61 weeks of extended parental benefits. You will qualify for up to $595 per week for maternity benefits and up to $357 per week for extended parental benefits. This period when you are receiving a lower taxable income may be the ideal time to withdraw from your RRSP.
Let’s assume that between EI and any withdrawals from your RRSP you are in the lowest tax bracket. In Ontario in 2022, the first $46,226 is subject to provincial income tax of 5.05%. Combined with the federal rate of 15%, your marginal combined tax rate is 20.05%. You decide you need $20,000 after tax to manage the time away from employment.
Everywhere in Canada, except for Quebec which has a separate tax schedule, your financial institution will withhold 30% and remit that amount to the CRA. The withholding schedule is as follows:
You may object to this table because even though you are withdrawing $20,000 you are confident that you will owe a lesser amount in tax. I have two responses. First, when you file your taxes, you may qualify for a refund depending on your other sources of income in that year. Second, you are not withdrawing $20,000. You are withdrawing $20,000 plus the tax. How much is the tax going to be? You can calculate it this way:
$20,000/(1 – 30%) = $28,571.43 total withdrawal
$28,571.43 – $20,000 = $8,571.43 tax withheld
Your T4RSP for that year will show total income from your RRSP of $28,571.43, with $8,571.43 being the amount withheld and remitted to the CRA by your financial institution.
In addition, you are likely to be charged an RRSP withdrawal fee. This depends on your financial institution, but $25 is typical and with Ontario’s 13% HST, that works out to $28.25.
To sum it all up, to get $20,000 in your pockets, it will initially cost you $28,599.68.
However, if the tax you owe on this withdrawal is only at the 20.05% rate, then you are likely to get some money back:
$20,000/(1 – 20.05%) = $25,015.63
$25,015.63 – $20,000 = $5,015.63 tax owing
$8,571.43 – $5,015.63 = $3,555.80 tax refund
That difference between the tax withheld and the tax owing makes quite a difference.
One thing you should remember, though, is that unlike the LLP and the HBP, which gives you a chance to put the money withdrawn back into your RRSP, there is no such opportunity for an RRSP withdrawal not made under one of those plans. Once withdrawn, the contribution room is gone. You can certainly use the contribution room that you already have but had not yet used, as well as the contribution room that you add each year from your qualifying income, but you cannot get the contribution room back once it has been used.
In short, withdrawing from an RRSP can make sense, but there is a tradeoff in any of the three scenarios. That is, you lose the opportunity to allow your investments to compound on a tax-deferred basis. While it is not as bad in the case of the LLP or HBP, which allows you to replenish your RRSP, regular withdrawals not made under a plan result in lost contribution room. These scenarios may be worth it, but they will have an impact on your retirement income.
This is the 125th blog post for Russ Writes.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.