It does happen, though, more often than you might think. Nearly 40 percent of Canadians withdraw funds early from RRSPs, according to a recent CBC-reported study. Even worse, they’re often not doing it for the right reasons:
“But more than a fifth of those who have withdrawn money early said they did so to pay living expenses, and 18 per cent reported they did it to pay down debt — two excuses the tax man will not accept as legitimate enough to waive the penalty for doing so.”
Just so we’re absolutely clear: a big reason for contributing to RRSPs (totally apart from the rate of return from any particular investment) is to reduce the amount of tax that you pay each year.
If you take out those funds early from an RRSP, you have to pay tax on them. It works just as if it was regular income.
So, as a general rule, it’s pretty simple: don’t raid your RRSPs.
Especially, don’t do it to pay for that tropical getaway or that big screen TV you’ve been eyeing.
Let’s run through each of these.
Taking Money out of an RRSP for an HBP, LLP or RRIF
The Home Buyers’ Plan lets you take up to $25,000 out of your RRSP and use those funds towards the purchase of your first home. You’ll have 15 years to pay it back, starting from the second year after you withdraw your money.
There are a few catches to this. You have to be considered a first-time homebuyer, as defined by the CRA. That might not be as simple as it seems: for instance, if your spouse has previously owned a home that either of you lived in for the preceding four years, you can’t use the HBP. Also, the money has to be in your RRSPs for 90 days prior to the withdrawal.
For many young home buyers, this can be a good option. After all, they might not have a lot of other savings.
But (and this is a big but) it’s not for everyone – and the benefits might just not be worth it.
Particularly for home buyers in pricey markets such as Vancouver or Toronto: as one Global News report noted recently, $25,000 isn’t a whole lot of money compared to the overall price of the home:
“When you’re facing average home prices closing in on $1 million, as many B.C. and Ontario residents do, the maximum HBP withdrawal can feel like a drop in the bucket, even if you join forces with a spouse, partner or friend for a combined $50,000 contribution.”
First, if you’re someone who has been able to save more and has built up savings in a TFSA, then you’ll want to use your other resources for the down-payment. Leave your RRSPs alone, so you won’t miss out on years and years of tax-deferred investment growth. We recommend not using the HBP at all in that case.
Taking money out of an RRSP for an LLP. Lessons to remember
Not many people actually know about the Lifelong Learning Plan, so it doesn’t get used much. But as more and more Canadians go back to school to upgrade their skills or train for a big career transformation, that could change.
The LLP lets you take money out of your RRSPs early to help pay for post-secondary education. Adults will use it when they’re going back to school. The program could technically be used by young students just starting out. However, relatively few have much in the way of RRSPs socked away at that early stage.
As stated earlier, if you can dip into savings instead of your RRSPs to pay for this, it’s a good idea. But if your options are more limited, it could be the way to go. That’s particularly the case if your new skills will open up more highly-compensated work. That way, you can make up for the lost years of investment.
Converting part of your RRSPs to a RRIF early
Your RRSPs convert to a RRIF when you hit the age of 71, but you can actually convert part or all of those funds before then. That way, you can take advantage of a tax credit on up to $2,000 of pension income which is available at age 65 (and in some limited situations at age 60). This could let you take up to $2,000 out of your RRIF without paying tax.
This would make sense if your only pension income was from government sources, like CPP or OAS. It’s not a good strategy if you also have a private workplace pension. In that case, it will already be using up your pension tax credit.
Taking money out of RRSPs for an emergency
With all the warnings we’ve noted above about how bad it is generally to withdraw funds prematurely from an RRSP (barring those government programs), it happens. Life happens.
People get into health emergencies that can wipe out other sources of savings. That does happen. If you have to raid their RRSPs to pay for treatment, you do what you have to do. The old saying of “at least you’ve got your health” applies. When you’re feeling better, you can get back to building up that nest egg.
Sometimes, Canadians will withdraw from RRSPs to pay down high-interest credit cards. This could actually be a credible idea, since it’s usually ideal to pay down debts first, before investing.
But the idea with investing is to build up resources. That way, you’re not facing that kind of crisis situation.
Need help deciding whether to take out RRSPs early? This might be a good reason to chat with one of our financial advisors