The Registered Retirement Savings Plan (RRSP) is a tax-sheltered investment account for Canadians to save for retirement. However, there may be times in your life where you need to access your money in this account before you retire. In these incidences, you want to ensure you withdraw from your RRSP without paying tax, or at least not paying very much of it!
If you don’t yet have an RRSP, you need to get one! The best place to open an RRSP is with Wealthsimple. There’s never been a better time to start investing in your future and building your long-term financial assets.
How the RRSP optimizes your income taxes
The RRSP defers your income taxes on investment income. Are your investments grow tax-free in the RRSP, and then only your withdrawals are taxed. Because most people do not make withdrawals until retirement, they usually pay less income taxes than they do on earned income during their working lifetime.
This is much different than unregistered accounts, where investment income is taxed differently depending on what kind of income it is. Interest, dividends, and capital gains are all subject to different income taxes. For a breakdown, check out How Your Investments Are Taxed.
Should you make an early withdrawal from your RRSP before retirement?
Ideally, you should not make any withdrawals from your RRSP before retirement. Unless you are facing extreme financial distress and have no other options, you should try to leave your RRSP alone. This is one of the reasons it is so important to have an Emergency Fund and cultivate multiple sources of income.
Nevertheless, there may be times in your life where it makes sense to cash out your RRSP. In those cases, one of the most important things you can do is minimize or eliminate the amount of tax you pay on your RRSP withdrawal.
How to withdraw from an RRSP without paying tax
Here are a few ways to reduce or eliminate the amount of tax you pay on early RRSP withdrawals.
Withdraw less than $5,000
If you withdraw from your RRSP, it will automatically be subject to withholding tax from your financial institution. However, you can minimize the amount of withholding tax by withdrawing a small amount.
Making an RRSP withdrawal of $5,000 or less is preferable because the amount of withholding tax increases for every amount thereafter. If you withdraw $5,000 or less from your RRSP, your withholding tax will only be 10%. If your income is very low that year, you may get some or all of that back leaving you with no income tax on your early RRSP withdrawal.
Withdraw up to $35,000 under the First Time Home Buyer’s Plan
The First Time Home Buyer’s Plan (HBP) lets you withdraw up to $35,000 from your RRSP to put a down payment on a home. If you are buying a house with a partner, they too can withdraw up to $35,000 from their RRSP giving you a total of $70,000 for a down payment. RRSP withdrawals are not taxed if they are made under the First Time Home Buyer’s Plan.
When you withdraw money under the First Time Home Buyer’s Plan, you eventually have to pay it back. If you do not pay back the full amount you withdrew in the required timeline, you will need to pay tax on the RRSP withdrawal amount outstanding.
Withdraw up to $20,000 under the Lifelong Learning Plan
You can withdraw up to $10,000 per year to a lifetime maximum of $20,000 from your RRSP under the Lifelong Learning Plan (LLP) in order to go back to school.
Like the HBP, you will need to pay back the amount you withdraw from your RRSP under the Lifelong Learning Plan. If you do not pay back the full amount you withdrew, you will need to pay tax on the RRSP withdrawal outstanding.
Withdraw from an RRSP in Retirement
Obviously the purpose of your RRSP is to provide income for you in retirement, so that’s the best time to make an RRSP withdrawal. If you don’t want to pay withholding tax on your RRSP, you need to keep your withdrawals low, which means you’ll need income from other sources.
This is why the Tax-Free Savings Account (TFSA) is the best account to invest for retirement. You should save and invest in your TFSA, then make your withdrawals from that account in retirement before drawing down on your RRSP or RRIF.
You may not be able to entirely avoid income taxes on your RRSP withdrawals, but strategically withdrawing from your TFSA first is the best to way reduce how much you need to rely on taxable income sources. With discipline and consistency, your TFSA can become a million-dollar asset.
How much is RRSP withdrawal tax?
Early RRSP withdrawals are subject to taxes in two ways: RRSP withholding tax and income tax. How much RRSP withdrawal tax you pay depends on the amount you withdraw as well as your total income and tax bracket for that year.
RRSP withholding tax rate depends on the amount you withdraw.
- RRSP withdrawals in amounts up to $5,000 are subject to a 10% withholding tax,
- RRSP withdrawals of $5,001 to $15,000 are subject to a 20% withholding tax.
- RRSP withdrawals over $15,000 will be subject to an automatic 30% withholding tax.
However, you also need to be aware of your income tax bracket for the year. Because withdrawing from your RRSP counts as income, you will pay income taxes on it. If you owe more than the withholding tax, you’ll be taxed again when you file your taxes.
Can you get RRSP withholding tax back?
Yes! If you withdraw from your RRSP during a year where you have a very low income, it is possible to get your RRSP withholding tax back. It will come as an income tax refund when you file your taxes.
Downsides to early RRSP withdrawals
While there may be times in your life that cashing out your RRSP makes sense, there are downsides to early RRSP withdrawals you need to consider.
Missing out on investment returns
If you take money out of an RRSP, it can’t earn any investment income for you. If you have no cash invested in the stock market, you can’t earn interest, dividends, and capital gains from it.
The best way to ensure longterm financial security is to keep your money invested as long as you can. This is the main reason it is so beneficial to begin saving for retirement when you’re young.
Loss of contribution room
Hands down the biggest consequence of early withdrawals from your RRSP is the loss of contribution room. Unlike the TFSA, when you take money out of your RRSP, you can’t put it back.
RRSP contribution room is valuable because of the tax-sheltering power of this account. When you lose contribution room, what you’re really losing is the ability to tax-shelter future income. There is a huge opportunity cost to this that should be considered seriously before you withdraw from your RRSP.
Final thoughts on strategies to withdraw from RRSP without paying tax
Withdrawing from an RRSP without paying tax is tricky because it’s a taxable account. The only way to do it is to make a withdrawal when you have a very low income, which is not always ideal. Instead, direct your efforts to building up multiple financial assets and income streams so you don’t have to rely on this account to get you out of a bind!