An RRSP is an excellent way for Canadians to save money for retirement. Putting your funds into an RRSP opens up the possibilities of enjoying a broad selection of investment products that include ETFs, stocks, and mutual funds. You also get tax advantages that ensure you don’t pay income tax on the accruing interest for any profits, including capital gains, dividends, or interest. However, this benefit only applies if your funds stay in the RRSP. Besides, the contribution money in your RRSP receives a tax credit, ensuring you pay less in income taxes.
The financial cost of RRSP Withholding Tax
The fact is life happens. And it can happen to anyone. For instance, your house roof collapses, or you lose your money in stocks or any other dire situation. If you take out money from your RRSP, it will come at a price. Withdrawing money from your RRSP before the maturation date comes at the cost of a Withholding tax, which will be taken from your account directly by the bank holding the RRSP.
The amount is then sent to the government. In sum, RRSP Withholding Tax is remitted to the Canadian government when you take out money from your RRSP before retirement. The latest rate of RRSP withholding tax is:
- 10% up to C$5000
- 20% for withdrawals between C$5001 and C$15000
- 30% for withdrawals above C$15000
The amount you pay as a tax depends on your area of residence and withdrawal amount. See the table below for the withdrawal rates as follows:
Please note that Quebec residents are liable to pay an extra 16% as provincial sales tax. If you don’t reside in Canada, you’ll be exposed to a charge of 25% withholding tax irrespective of your withdrawal size.
It is also worth mentioning that this isn’t the only tax you’ll pay. Monies you withdraw from your RRSP form part of your income. The implication is you need to declare it in the tax year it was drawn. If that withdrawal pushes you up a higher tax bracket, that means more income tax payments for you.
Withdrawing from an RRSP before retirement should only be in a dire situation where there is no other option. Once you withdraw funds from your RRSP, your bank will give you a T4-RRSP showing the amount withdrawn and the amount of tax withheld. It is now up to you to declare this amount in your T1 in the tax year it was withdrawn. The tax rates for the current year are provided by the Canada Revenue Agency (CRA).
Also, bear in mind that the contribution room once used isn’t returned. The CRA only gives you one chance at contribution, and you don’t get to add the amount of your withdrawal to your existing contribution room. So if you withdraw C$10,000, you won’t be able to contribute that C$10,000 in the future. The consequence is that you miss additional income you’d have made from compounding.
How to avoid Withholding Tax when withdrawing from your RRSP
There are two ways to avoid withholding tax without getting sanctioned by the CRA. These include withdrawals made under the Lifelong Learning Plan or the Homebuyer’s Plan.
Lifelong Learning Plan
Members of the Lifelong Learning Plan may withdraw a maximum of C$10,000 from their RRSP for each calendar year. This fund can be extended up to C$20000 tax-free for your Significant Other or common-law partner. The money doesn’t have to be withdrawn in whole and can be staggered over four years so long as you stay within limits of C$20000.
Participants have ten years to pay off the funds starting at the fifth year mark of your first LLP withdrawal. The CRA will provide you with every document you need to make your payments, including your initial fees, the amount of your next LLP payment, and the LLP balance.
This program enables participants to take out up to C$25,000 in tax-free dollars from their RRSP in one calendar year to purchase a house. Individuals have up to 15 years to pay off the funds, with repayments kick-starting from the second year of withdrawal. The CRA will provide you with your yearly statements, including outstanding balance and subsequent payments. There are eligibility requirements, including establishing that you’re purchasing a home for the first time.
Implications of Withdrawing RRSP before Retirement
The most obvious consequence of taking money from your RRSP before maturity is the withholding tax that will be deducted. Withdrawing before retirement can have profound implications for your tax bill because you’ll be paying a combined income tax in addition to the withholding taxes.
Another important factor to consider is that you’ll be losing a significant sum of money from compounding. Taking money before retiring hurts your retirement fund, primarily because contribution room once lost cannot be recovered.
Be mindful that withdrawing smaller sums of money in a short period to avoid paying higher withholding taxes also has its drawbacks. Your bank can still subtract the total amount of withholding tax that accrues for the whole amount. For instance, if you withdraw C$10,000 staggered into four withdrawals of C$2,500 to avoid paying the 20% withholding tax, your bank may still charge you 20% after your last withdrawal.
The fact is; withdrawals before retirement isn’t a brilliant idea, and you should focus on finding alternative means of shoring up your income before taking money from your RRSP.
What to Do for Emergency Funds
Take money from your TFSA
A TFSA is an excellent option for keeping emergency funds because you can replace any money you withdraw the following year. Be mindful you have to repay your TFSA on time to lessen your investment growth loss.
Withdraw funds from Non-registered Assets
Withdrawing funds from assets like mutual funds, savings bonds, or GICs do not increase your taxable income even though you forfeit future investment earnings. Sometimes, your best bet is to tighten up your belt to ensure you have adequate funds to sustain the type of lifestyle you want.
How much tax do you pay on RRSP Withdrawals in Canada?
Taking funds from your RRSP subjects you to a withholding tax of 10% for amounts up to C$5000. Withdrawals ranging from C$5001 and C$15,000 are subject to a 20% withholding tax rate. Any withdrawal above C$15,000 will cost 30% in withholding taxes.
At what age can I withdraw RRSP without Penalty?
Seventy-one years is the RRSP withdrawal age. Anything less, and you may be subject to a penalty in the form of withholding taxes.
Can I withdraw from my RRSP at 60?
Yes, you can. But the more you wait, the larger your payments.