Should You Ever Withdraw Money From Your RRSP?

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.

How my RRSP helped me pay off my student loans, go back to school, and save for the future

Ok guys, RRSPs are getting way too much flack in the Canadian personal finance community. With most people singing the praises of TFSAs, we’re forgetting a financial truth:

RRSPs are still awesome.

…but they’re not for everybody.

(well, they are for every Canadian in a legal sense, but not everybody should take advantage of them all the time)

I opened an RRSP for my 25th birthday, because at my quarter-century existence milestone I was going through this weird phase of feeling “old” and “grown-up”. Now that I’m 28 I realize how ridiculous it is to feel old at 25, but that is the foolishness of youth. My contributions to my RRSP at that time were minimal, because even though I was eager to start saving for retirement, I had figured out enough about money to know an RRSP wasn’t the best savings vehicle for me at that time because of my low income.

Fast forward a year later when my income jumped and I started a job with an employer pension. The mandatory contributions to my employer pension counted as RRSP contributions, because it was money going into a registered retirement account. Employer pensions are rare these days, so most people will have a choice whether or not to contribute to their retirement accounts. However, even if contributions weren’t mandatory, I still would have kept saving in an RRSP.

My income was over $50,000 annually and RRSP contributions helped minimize the amount of income tax I paid.

Paying less income tax meant I got bigger income tax returns back (I never requested my employer reduce my tax rate because with the variable income I was earning from freelance writing & blogging, it was difficult to predict the taxes I would owe, so I erred on the side of receiving a return instead of paying!). Large income tax returns helped me wipe out my massive student loan debt AND allowed me to boost my savings and investment accounts.

Consequently, not only did I have money socked away for retirement, I was able to get out of debt super fast and start investing in the stock market.

RRSPs have always been, and still are, part of my long-term wealth-building strategy. 

If I over-contributed to my RRSP — what I mean by that is, put more money into it than I needed to maximize my income tax return — I carried the deduction to a future year. I don’t even know if people realize you can do this, but you can contribute to your RRSP and claim the deduction in a later year.

I have contributed more to my RRSPs than I’ve claimed in deductions.

And that money is growing with interest and dividends that won’t be part of my deduction. In other words, contributing to my RRSP is earning me some free money. Who would say no to that?

Now that I’ve decided to return to school for my MBA, my RRSPs are a backup plan for funding my degree. I can borrow up to $10,000 per year to a maximum of $20,000 under the lifelong learning plan. This represents approximately half of the entire cost of my degree.

You know what happens when you borrow from yourself to pay for something? 

You don’t go into debt.

Scholarships and savings have spared me withdrawing any money from my RRSP to fund my educational pursuits thus far, but I like knowing I have tens of thousands of dollars on hand if I needed. I won’t need to take a break from my studies or pick up a part time job in order to earn money to pay for my tuition, my RRSP is always available to me and the only person I have to pay back if I use it is myself. Talk about peace of mind!

So I want to take this moment to thank my RRSP for helping me pay off my debt, put money away for when I’m old & grey, and let me go back to school without fear of poverty.

If it weren’t for my RRSP contributions, I’d be way further behind in my debt repayment and savings progress.

When should you NOT contribute to an RRSP:

- you earn a low income. As a general rule, the threshold for justifiable RRSP contributions is $50,000 but this depends on a number of factors, namely what other deductions you can claim.

- you haven’t maxed out your TFSA. An RRSP is a tax-deferred account, which means you’re going to pay taxes on on the money in the account, just at a later date. A TFSA on the other hand is a tax-free account, which means you never pay taxes on the money in that account. The trade off is you can’t claim TFSA contributions when you file your taxes the way you can claim RRSP contributions. For ultimate tax-minimization, you should try to max out your TFSA before your RRSP, regardless of income.

- you don’t like money. If you don’t have a real interest in managing your money well, you want to make the choices that will hurt you the most, and this includes never contributing to an RRSP. Maybe don’t even file your taxes at all, because if you’re going to financially self-sabotage, might as well go all out.

In conclusion, the Canadian PF community has to stop slamming RRSPs like they’re financially toxic and recognize some of the benefits of putting money away in these accounts.

How much should you have saved for retirement by age 30?

I saw a post of the same title in my twitter feed last week, but when I went back to read it, I couldn’t find it again so my apologies to the author, I’m sure you did a much better job than me. In any case, you got me wondering:

How much should you have saved for retirement by age 30?

At 27, my retirement nest egg is somewhere in the neighbourhood of $20,000. If you add in my TFSA (and I don’t, because I might spend that on other stuff) it’s even higher. I started saving at 25, which is early or late depending who you talk to in the personal finance community. I started slowly, but this year I’m on some kind of retirement-saving bender because the stats about how little people save for their retirement really freak me out. Essentially very few people save, and those that do aren’t very good at it. I don’t know how anyone in their 40′s sleeps at night with $10,000 or less in the bank, but they probably have a higher pain tolerance than I do, or considerably less FOMO. I know that if I want to maintain my groovy lifestyle into my 70s and 80s — and believe me, I will — I need to make sure I have the funds to do it.

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So it’s best to establish milestones and goals so you know you’re on track. I don’t put a lot of thought into my life at age 65 because it’s nearly 40 years away, but age 30 is something I can work with. Word on the street is:

You should have 1x your annual salary saved in your retirement account by age 30.

That seems doable, right? I’m more or less on track, unless my salary jumps significantly in the next year or two, in which case I would need to have more, but that’s not a bad problem to have ;)

If you have more than 1x your annual salary saved, awesome! If you have less, you’ve got some work to do. If you have nothing, you have a lot of work to do. If you think saving for retirement when you’re in your 20′s is unimportant, I get it. I’m probably the least concerned of all personal finance bloggers about how wealthy I’ll be when I’m old and grey. I don’t like saving for retirement at all, but I do it anyway because I like the idea of being poor even less. Don’t be a self-saboteur and save nothing for retirement in your 20′s, it’s a huge pain in the ass to play catch up every decade thereafter.

How I save for retirement:

Without choice: work deducts 11% of my gross pay and saves it for me. I never see that money, so I never get to spend it. There’s nothing quite like being volun-told to get stuff done.

Automatically: I have transfers set up every payday that direct a small part of my paycheque to my RRSPs. If I didn’t think the above was already enough, I’ve got my own thing going in the same theme: money in, and money out before you can spend a dime. I like locking money in my RRSPs because I can’t get it out to spend it on dresses.

With time: I may add funds to my accounts grudgingly, but I appreciate the interest and dividends that boost the small sum each month. Starting early and saving regularly means my retirement nest egg has decades to grow, and I’m happy to report that, slowly but surely, that’s what I’m already seeing.

How much have you saved for retirement? How much more did you need? How are you getting there?

Ways to use your RRSP for things other than retirement

If you frequent Canadian personal finance blogs, you’re already familiar with the Registered Retirement Savings Plan (RRSP). However, while members of the personal finance community might be privy to the perks of the RRSP, the average Canadian is not.

Only about 38% of Canadians contribute to an RRSP. The ones that don’t complain about lack of funds, market volatility and feeling that it simply wasn’t “important” to make a contribution. Source.

I didn’t start my RRSP until I was 25. I put $2,500 in that year, and this year (two years later) is the first time I’ve claimed the deduction. Last year and the year before, I contributed to my employer’s mandatory pension plan, and claimed those deductions, which also counts towards my RRSP contribution room. Despite having a retirement plan through work, I’m contributing to my RRSP for a few reasons:

primarily for the income tax break

secondly because putting money in now means it will earn interest and compound for decades

and lastly, because there’s the opportunity to use that money to achieve other financial goals other than retirement.

That last one is something I think most 20-somethings don’t know about. Maybe if they did, they’d start building their retirement funds a lot sooner.

RRSP Fast Facts:

  • your annual contribution limit to your RRSP is 18% of your gross income to a maximum of $23,820 (for 2012, this limit generally increases every year).
  • unused contribution room can be carried forward to future years
  • you can contribute to your RRSP but claim the contribution in a future year (this gives time for your contribution to compound and you can still use the deduction for taxes when you’re earning more in a later years)
  • you can keep your RRSP savings in any savings or investment vehicle, including: savings account, GICs, mutual funds, stocks, etc.

The First Time Homebuyer’s 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. If you’re purchasing with a partner, they can also withdraw up to $25,000 from their RRSP. This can give a couple up to $50,000 to put down on their first home. The catch is this is just a loan: you will need to put back the money you borrowed from your RRSP. You have 15 years to pay back the amount you withdrew. If you borrowed the full $25,000 this is about $139/mo. But hopefully if you had $25,000 in the RRSP in the first place, you’re a good enough saver to work $139/mo of saving into your budget ;)

Remember: in your 20′s, time is nearly as valuable as capital. The sooner you put your borrowed money back, the longer it has to compound which means a greater nest-egg when you actually do need it for retirement.

The Lifelong Learning Plan

Like the First Time Homebuyer’s Plan, the Lifelong Learning Plan (LLP) will allow you to withdraw an amount tax-free from your RRSP that you will later need to pay back. The limit for the Lifelong Learning Plan is $10,000. You have 10 years to pay this amount back, which works out to $1000/yr or about $83/mo. Again, no big deal if you’re a good saver! This is a great option if you’re seeking to increase your education to boost your income. High paying degrees like an MBA or an MD can justify the investment, but I’d discourage you from borrowing from your retirement nest-egg just to study something for interest sake.

Remember: if you borrow under the LLP, you have to actually go to school. If you withdraw the money but fail to enrol in an accredited program, you’ll have to pay the money back in less than 10 years.

Can you withdraw from your RRSP for other non-retirement reasons? 

Technically, yes — but you shouldn’t. When you withdraw from your RRSP outside the Homebuyer’s or Lifelong Learning plan, not only is your withdrawal taxed, you never get back the contribution room. If you’re in absolute dire straights, ie. jobless with no other source of income, withdrawing from your RRSP might be worth the the drawbacks, but in any other circumstances it’s likely to do more harm than good.

Confession: I took the loan

Remember last year when ING offered me an RSP loan of up to $10,000 and I wrote an entry musing about borrowing to invest?

Well, I never followed up, but I did actually end up borrowing $2,000 of that offer — and most of my posts thereafter about “contributing to my RSP” actually should have read “paying down the RSP loan”. It didn’t make much of a difference, since previous to taking the loan I had been putting $150/mo towards my RRSP and the payments on the loan were something like $165/mo.

Now ING is offering me the same $10,000 loan offer, but I’m not going to bother. Truthfully, I don’t know how much it really matters. Now that I have a pension with employer matching from work (something I didn’t have last year), my RRSP is taking a back seat until my student loans are paid off, my TFSA is maxed out, and I need to start dodging the tax man. So what was my reasoning for borrowing last year?

- I wanted to invest, not merely sock the cash away in a savings account.

- I felt like my current RRSP was too small to do anything.

- I just wanted to see what borrowing to invest was like.

So, I split the $2,000 equally between a GIC (1.5 years, 2.5% interest) and mutual funds (ING’s Streetwise Balanced Fund). Over 2011, the mutual fund has returned $30.70 in dividends (though the market’s a bit down right now so I only see a $15 profit — but I’m pretty sure it will go back up, these things can depend on the day) and the GIC is set to mature July with $37.78 in interest. Which means I’ve made $68.48 in profit for 2011 on the money I borrowed. The loan itself was at an interest rate of 3% over 12 months, and cost me about $27 in interest.

Therefore, I made about $40 last year by borrowing to invest in my RRSP.

Now, $40 isn’t very much, but it was immediately reinvested into the RRSP so if we let it compound for another 40 years maybe it will amount to much more ;) Also, I’m generally enough of a penny pincher to get excited about $40 — so how come I don’t want to borrow again this year? A few reasons:

- I don’t care about my RRSP anymore for reasons already mentioned.

- This year’s 1.5 year RSP GIC is only for 1.5%, not 2.5% like last year.

- I’m taking a JUST SAY NO approach to debt.

Nevertheless, I’m glad I borrowed last year. Even though it had zero benefit to me tax-wise (the main reason people borrow to max out their RRSP), I don’t think I actually would have been able to put $2000 away last year on my own. If you remember, I had a pretty severe breakdown spiritual awakening last spring, which included a month in Europe where, not only did I not work for 30 days straight, I spent $6,000. I immediately followed this financial irresponsibility with coming home to only work part-time. Frankly if I could have gotten out of payments on my RSP loan during that time, I probably would have — which means I would haven’t the full $2,000 + $40 there I do now. So ultimately I think I benefited from borrowing, but I’m counting on 2012 to be breakdown spiritual-awakening-free to justify not doing it again.

PS. my $500 in my RRSP savings account has earned $8 in interest. GO LITTLE RRSP, GO! =p