I recently got in a debate with a friend about withdrawing from your RRSP. He reasoned that in a low income year (ie. as a student), it could make sense because the tax hit would be less than that you would experience withdrawing your money in retirement. I disagreed for a number of reasons — namely that instead of deregistering the funds, he should withdraw them under the lifelong learning plan, which he didn’t even mention for some reason — and I have decided to share them with you here.
“Safe” Ways To Withdraw Money From Your RRSP:
The First-Time Homebuyers Plan – The first time Homebuyer’s Plan (HBP) will allow you to withdraw up to $25,000 from your RRSP for a down-payment on your first home. You have 15 years to pay back the amount you withdrew. If you borrowed the full $25,000 this is about $139/mo.
The Lifelong Learning Plan – Lifelong Learning Plan (LLP) will allow you to withdraw $10,000 per year up to a maximum of $20,000 for education costs. You have 10 years to pay back the amount you withdrew. If you borrowed the full $20,000, this is about $167/mo.
The problem with the “safe” withdrawals:
Distressing data collected by the Canada Revenue Agency reveals nearly one-half of people who used the First-Time Homebuyers Plan, failed to meet the repayment requirements. Consequently, they now need to pay income tax on that amount for withdrawing it from their RRSP. I haven’t been able to find data on repayment of the Lifelong Learning Plan (it’s not utilized as much as the HBP), but I’m doubtful borrowers are perfect at paying that one back either. Borrowing for a home or your education can be justified in the right circumstances, but no matter what, you miss out on compounding. If you fail to follow the repayment schedule of the LLP or HBP, you negate any benefit of borrowing under these plans and end up hurting yourself financially.
Risky Withdrawal From Your RRSP:
Using Your RRSP As An Emergency Fund or to Supplement Income – I can’t blog enough about the importance of establishing an emergency fund, but since this is “Money After Graduation” and not “Emergency Funds After Graduation”, I try to hold off. You should never be without some liquid cash to cover unexpected expenses. It’s important to contribute to your retirement accounts, but if you do it just to withdraw the money during a future time of crisis, you’re undoing all your hard work and then some. If you don’t have cash on hand for unexpected expenses and emergencies, then you can’t afford to contribute to your retirement accounts. DON’T PUT MONEY IN YOUR RRSP IF YOU DON’T ALREADY HAVE $1,000+ SET ASIDE IN A TFSA FOR “JUST IN CASE”. Ever, ok? Just don’t do that.
Why this is so goddamn risky:
You don’t know what your income will be in retirement. Predicting the future is impossible, I get it, but this is shooting yourself in the foot hoping you miss your toes. As you get further along in your working career and closer to retirement age, it will become easier to predict your retirement income and compare it to your current earnings, but if you’re a high-earning ($70,000+/yr) twenty-something like my MBA classmates, it’s all guesswork. Find another way to get money.
You’re still being taxed. Even if you estimate your current tax bracket in a low income year is less than that you expect in retirement, you’re not pulling the money out tax-free. The $10,000 withdrawal my friend was suggesting would be taxed at 20%. Uh? Wasn’t the point of withdrawing in a low or no income year to avoid taxes? What’s the point of taking out $10K if you’re only going to net $8,000 of it? You better be pretty desperate for cash if you’re willing to see $2,000 of your money go to government. Remember this is $2,000 you don’t get to spend on anything and will never compound in your retirement accounts. Would you rather pay $2,000 in taxes now or have $6,334 in 40 years when you retire? Because that’s exactly what this is.
You never, ever get the contribution room back. Personally, I think this is the biggest downside to deregistering funds from an RRSP: once you do, that money is gone. You can’t put it back. It’s not like a TFSA where what you withdraw becomes new contribution room the next year. If you take money out of your RRSP you can’t put it back. Don’t throw away things you might need later.
You miss out on decades of compounding. The closer you get in age to retirement, the less disastrous withdrawing from your RRSP early becomes. It can even be beneficial to flatten taxes in your later working years. However, if you’re in your 20’s, deregistering RRSP money cost you big time in the long run. I ran a few numbers in Excel just for kicks, and found $10,000 invested in your twenties at a paltry 3% will grow to over $30,000 by the time you retire at 65. With over $20,000 of “free money” in interest, I can’t really wrap my head around why anyone would do this.
What my silly friend should do: if he needs $10,000 in 2014 to cover expenses, he should pull the money out of his RRSP under the Lifelong Learning Plan and make a plan to pay it back on schedule after graduation.