Under the Home Buyers' Plan, you can withdraw up to $35,000 from your RRSP to buy or build a home—provided that you are a first-time buyer (Getty Images/Cavan Images)
For anyone who wants a tax-efficient way to build up their nest egg, a Registered Retirement Savings Plan has long been a popular tool.
As the name implies, RRSPs are designed primarily as a way to save for retirement. Still, there are some circumstances in which it may make sense to cash in a portion of your savings early—or at least to access your accumulated funds. Here are some of them.
1) WANT TO BECOME A HOMEOWNER? USE THE HOME BUYERS’ PLAN
If you would like to get a toehold in the real estate market but are struggling to save for a down payment, a Home Buyers’ Plan (HBP) could give you the financial boost you need.
Under the plan, you can withdraw up to $35,000 from your RRSP to buy or build a home—provided that you are a first-time buyer, (defined as not having owned a home in the four-year period preceding a home purchase). The amount withdrawn is repayable over 15 years, says CPA Bob Gore, principal of Robert Gore & Associates Chartered Professional Accountants. “You make the repayments as an RRSP contribution, and you designate the contribution as a repayment on your tax return. If you don’t make a repayment, the required amount becomes an income inclusion.”
As Gore explains, the plan is ideal for anyone who is finding it difficult to come up with a lump sum for a down payment. “I know people who have a good income, but still don’t have enough accumulated cash,” he says. “So they might make fairly large RRSP contributions for a year or two before buying the house. They’ll get the deduction for the contributions, then use the HBP withdrawal.” (He adds that contributions must remain in the RRSP for at least 90 days before they can be withdrawn under the HBP.)
Gore cautions, however, that the HBP only makes sense if you are a good candidate for an RRSP in the first place. If, for example, your annual income is near the top of the lowest income tax bracket ($47,630 for 2019) and making a contribution is going to push it below that level, an RRSP won’t be as tax effective as it would be if your income were higher, because deductions are tied to income; if you are in a lower tax bracket, you will receive a smaller deduction for your contribution.
“But if your income is above $47,630—say you are making $60,000—you could be buying almost $13,000 of RRSPs, which would reduce your income to $47,630,” says Gore. “If you do that for a few years, you will accumulate $35,000 to augment whatever other savings you have. And you will have recovered a good percentage of your RRSP contributions in tax savings, further augmenting your overall savings.”
2) WANT TO GO BACK TO SCHOOL? USE THE LIFELONG LEARNING PLAN
If you’d like to develop new job skills or even change careers completely, you can take advantage of the Lifelong Learning Plan (LLP), which allows you to withdraw funds from your RRSP to fund tuition and other education costs.
Under the plan, you can withdraw up to a cumulative total of $20,000 from your RRSP—up to $10,000 in a calendar year. “It’s the same idea as the HBP, except that in this case, the funds have to be repaid over a period of 10 years to avoid an income inclusion,” says Gore. “It’s a good option for an RRSP contributor who wants to improve their skills or change jobs but finds the prospect of going back to school just too daunting.”
Gore adds that you could theoretically withdraw up to $10,000 each year for two years up to that $20,000 cumulative threshold. If you are considering the LLP, you should also determine whether a taxable withdrawal would make more sense—that is discussed next.
3) FACING INCOME VOLATILITY? CONSIDER AN EARLY WITHDRAWAL
While the HBP and LLP are the only government plans that allow you to access funds tax-free from your RRSP, there are some situations that might merit an early withdrawal. For example, if you have been working for a number of years and want to take a sabbatical, you might want to withdraw some funds from your RRSP and contribute them into a TFSA. Or perhaps you want to go back to school and use the funds for tuition. While the withdrawal would be fully taxable, the effective tax rate may be very low if you had little or no other income for the year you took the money out. You will need to make sure you consider all sources of other income when making this decision so you can estimate the tax on the RRSP withdrawal.
Gore adds that you might consider a similar strategy if you are dealing with a lot of income volatility. “For example, let’s say you have a large income one year and make an RRSP contribution,” he says. “Then your income collapses the following year. In that case, you could move the money from an RRSP to a TFSA without paying much tax. Then if your income rose steeply again the following year, you could contribute to an RRSP again, and so on.” Keep in mind, though, that if you make a contribution knowing that you will be taking the money out in the near future, that contribution and withdrawal will still use up your cumulative RRSP room.
4) LOOKING AT AN OAS CLAWBACK? DRAW DOWN YOUR RRSPs
In some cases, says Gore, it makes sense to use your RRSPs as an income-smoothing mechanism in retirement.
“Say, for example, you expect to retire at 60, and your income will drop considerably,” he says. “But five years after that, you will draw a company pension, CPP, OAS, and some income from your RRSPs. If you add it all up, your income could move beyond the OAS clawback threshold, which is $77,580 for 2019 ($79,054 for 2020). The clawback means your OAS will be subject to a 15 per cent tax. That’s essentially an extra income tax.”
If you know this is going to be the case for you, it may be worth removing some funds from your RRSP during your lower-income years. “You may pay tax at a fairly moderate rate during those years,” says Gore. “Then when your CPP, OAS and possibly your company pension kick in, you can reduce your withdrawals so your overall income is smoothed. That could save a significant amount of tax, because the amount you pay if your income is stable over a number of years is lower than it would be if your income was volatile.”
In some cases, too, you might want to withdraw most or all of your RRSP funds before you even start collecting OAS and CPP. “If you know you are going to be facing an OAS clawback, you can delay receiving your CPP and OAS right up until age 70. So if you don’t need the money, it may make sense to wait. Each year, your benefits increase.” Generally speaking, deferring can be advantageous provided that you reach average life expectancy.
However you decide to use your RRSPs, Gore stresses that caution is the watchword. “In most circumstances, withdrawing your money early is defeating the whole intent of an RRSP, which is to contribute funds and let the money compound and grow over the years until you retire,” he says. “Also, since withdrawals are taxable, you have to measure the rate at which you draw any money out.
“Ultimately, you should look at an RRSP as part of a lifelong savings plan, which might also include debt repayment, TFSAs, and possibly some non-RRSP stocks or other investments as well as life insurance. All of those components should work together—so planning is absolutely essential.”
WANT TO LEARN MORE ABOUT SAVING FOR RETIREMENT?
CPA Canada has a number of resources that can help, including understanding RRSPs and TFSAs and The Procrastinator’s Guide to Retirement. To plan a financial literacy session in your community, see Planning for retirement.