What’s the problem with raiding my RRSP?
First off, remember why you contributed to an RRSP in the first place.
Your investments — cash, stocks, bonds, mutual funds, whatever — are growing inside your account every year, tax free. And when you finally retire and start taking money out, you’ll likely be taxed at a much lower rate because you aren’t earning as much anymore.
So when you take money out of your RRSP early, you lose out on the opportunity to make valuable tax-free earnings. Over the long term, your withdrawal will affect how much money you have in your golden years and may even delay your retirement.
The other downsides are more immediate.
“The tax burden can be substantial because whatever you withdraw is going to be taxed as income,” explains Liz Schieck, a certified financial planner at the New School of Finance in Toronto, an advice-only firm. “You’ll lose a lot of savings right off the bat.”
You also permanently lose your contribution room when you withdraw from an RRSP. While your unused room rolls over from year to year, if you were making the maximum allowable contributions, you won’t be able to make up the difference later.
Worst of all, in addition to paying more in income tax, you’ll be penalized with a hefty “withholding tax” on the amount you take out. Outside Quebec, you’ll pay a 10% penalty on withdrawals up to $5,000, 20% on withdrawals between $5,000 and $15,000 and 30% on withdrawals over $15,000.
What are my other options?
In an ideal world, everyone would have been able to prepare. Financial experts say one of your first priorities with extra money is to squirrel away enough for at least three months to six months in a high interest savings account — in case disaster strikes.
“I always advocate for having an emergency fund, but if you don’t have one, you have to look at other places,” says Julia Chung, partner and CEO of Spring Financial Planning in Vancouver.
The obvious place to turn, Chung says, would be any Tax Free Savings Accounts (TFSAs) you might have. They allow tax-free withdrawals that won’t affect your contribution room in the future. Just remember that any money you take out cannot be returned in the same year, so you’ll have to wait before you put it back in.
You might also be able to rely on help from various levels of government. They’ve introduced several programs to ensure people can hold on to their homes and pay for groceries until they find their feet again.
See whether you qualify for any of the following:
The Canada Emergency Response Benefit (CERB), which offers $500 a week for up to 16 weeks. More people qualify for CERB than traditional unemployment insurance, including contract workers and the self-employed.
Mortgage deferrals, which pause payments to your lender for a while. Keep in mind that, in all likelihood, interest will continue to accrue during that time.
Municipal and provincial assistance, such as property tax deferrals or financial relief from utility providers like Ontario’s Hydro One. Check your city and provincial websites to see what’s available.
You can also consider taking out a personal loan or line of credit — but don’t just think about how much you need. Have a strategy to pay it back within a specific time frame and shop around for a low rate.
Try an online service like LoanConnect, which will help you compare multiple lenders with lower terms. That way you can pay off your debt quickly and save hundreds if not thousands on interest.
What if my only option is to cash out my RRSP?
Schieck says there are times when raiding your RRSP may make sense. For example, if your only other option is to take out a high-interest payday loan, cashing out your RRSP may be a better idea.
“But generally, only do this as a last resort,” she says.
Just never forget that withdrawals are 100% taxable.
“Depending on how much money you make throughout the year, you may end up owing money in income taxes when you go to file, even though some taxes are withheld [when you withdraw the money],” explains Chung.
She adds that this extra income from your RRSP may also affect your ability to receive the same Canada Child Benefit or GST credit that you currently qualify for.
Both experts agree that consulting a financial advisor who can review your needs and income will help you make the most informed decision.
“Think it through and understand the implications of your choice,” says Chung.
What if the government allowed tax-deferred RRSP withdrawals?
Plenty of Canadians are urging the government to let them borrow from their RRSPs or Locked In Retirement Accounts (LIRA) tax-free, with the option to top up their accounts again later.
The current Home Buyer’s Plan could be a precedent. It allows Canadians to borrow up to $35,000 from their RRSPs to buy their first home and pay back the amount over a 15-year period — without losing the contribution room and without withholding taxes.
If the government offered a similar deal for the COVID-19 crisis, it would be worth looking into, but don’t cash out too quickly.
“It will involve payback, so make sure that you can afford to have that new bill as a part of your monthly fixed expenses in the future,” says Schieck.