What you need to know about RRSP withdrawal penalties

Registered Retirement Savings Plans (RRSPs) are reliable vehicles where you save up for your retirement. However, there are instances when taking out your savings from this fund becomes unavoidable.

Now, as effective as an RRSP is, making withdrawals from these highly tax-benefitted plans might leave a significant impact on the tax bills. In fact, you might have to pay some pretty hefty amount as a tax due to the withdrawal, instead of saving up on taxes as your original plans were.

So, how would you make the most of the RRSP and what are potential losses that you can suffer from making a withdrawal? Read on and visit this link to know more.

The Right Time To Withdraw From The RRSP

You get to withdraw from the RRSP at any time provided the funds aren’t there in locked-in plans. However, the amount has to be mentioned as your income at the time of tax filing.

In certain situations, you can make a tax-deferred withdrawal from the RRSP. For example, when the funds are spent to buy a property for the first time using the home buyers’ plan or to fund education using the LLP (Lifelong Learning Plan). Now, for every scenario, zero withholding taxes get paid. This withdrawal is not taken as income if the withdrawal gets paid back in the RRSP funds in the applicable timelines.

Compulsory RRSP Withdrawal At The Time Of Maturity

The RRSP funds reach maturity at the last day of that calendar year when you turn seventy-one. Here, you get to access the RRSP assets using three maturity options. Now, the tax implication of the decision is based on the options you select.

1. Make lump-sum RRSP withdrawals

If you withdraw the entire amount in the RRSP as a lump sum, you will have to pay withholding tax on that withdrawn amount. This tax is taken immediately from the withdrawal and then, paid to the Canadian government.

Moreover, the amount has to be included in your income at the time of tax filing.

2. Convert your RRSP into RRIF

You can convert the RRSP fund into a Registered Retirement Income Fund (RRIF). The latter gets you a seamless flow of the retirement income and the minimum amount to withdraw annually.

However, there are a few things to remember when taking an RRSP to an RRIF:

a.    Annual withdrawal:

You need to make yearly withdrawals from the RRIF fund. The minimum withdrawals should show up in the taxable income annually but aren’t a part of the withholding tax during the withdrawal. As such, anything that you withdraw over the minimum amount comes under withholding tax.

b.    Not having enough money:

If your returns do not exceed the RRIF withdrawal rate, you might outlive the savings eventually.

3. Buy an annuity

RRSPs can be converted to annuities to get a guaranteed income for a particular period or a lifetime. Also, withholding tax is not applicable on the amounts you use to buy annuities. You might need to pay taxes on that income when you start getting payments.

Withdrawals Made From An RRSP Before Its Maturity

It is important to understand the tax implications of making withdrawals from the RRSP before it reaches maturity so that you know whether you should take that step. Making early withdrawals lead to:

1.   Paying withholding taxes:

The rate of withholding tax changes based on the withdrawn amount and the province where you reside.

2.   Paying an income tax:

The withdrawals are reported on the tax returns as your income. If the present income is more than the retirement income, paying more taxes right now would be inevitable.

3.   Losing out on tax deferments:

As RRSP contributions tend to compound in the course of time, even the smallest withdrawals of today have a major impact on the savings later.

4.   Losing the contribution room:

Withdrawing funds from the RRSP makes you permanently lose that contribution room you had previously utilized for making the contribution.

Withdrawing From The RRSP And Not Paying Taxes

Tax-deferred withdrawals from the RRSP are possible when the withdrawn funds can be used for financing your studies or buying your first property.

Home Buyers’ Plan

A home buyers’ plan comes in handy when purchasing a home for the first time. This plan lets you withdraw at least $35,000 with zero withholding taxes. You do not even need to include the withdrawal as your income to invest in your first home. You will just have to meet the eligibility criteria set by the CRA (Canada Revenue Agency).

Repayments start after two years of withdrawing the funds. You get fifteen years for completing the repayments to the RRSP. You will get a yearly statement of funds from the CRA that outlines your payments, balance, and the minimum amount you paid for the given year.

Lifelong Learning Plan

The other option is the lifelong learning plan that lets you take out money from the RRSP to pay for full-time training or education for you, your common-law partner, or your spouse. This withdrawal isn’t taxable if you pay back the funds to the RRSP within ten years. The payback needs to start five years after the first withdrawal.

You can withdraw at least $10,000 yearly for two years if you meet all the other criteria and regulations.

Understanding Spousal RRSP Withdrawal

Withdrawals you make from the spousal RRSP are only possible by the person for whom this plan is acting as a retirement fund, also known as the annuitant.

In case you make contributions to your spousal RRSP at the time of withdrawal or two years prior to that, you will have to include this withdrawal amount as your income. It is called the rule of attribution.

The Bottom Line

Understandably, there are situations where taking money out from the RRSP savings becomes necessary. However, it is important to understand the tax implications of taking such a step. Hopefully, you have received some direction in this regard today. Consider all the pros and cons of the situation and decide on withdrawing a part of or the entire amount in the RRSP.