Avoid RRSP Early Withdrawal Penalties With These Alternatives

It’s remarkable how spontaneous financial decisions may turn into serious financial burdens in life. We all know someone who regrets missing credit card payments, forgetting to pay monthly payments for digital services. Taking money out of your RRSP while you’re working could be another financial regret.

An RRSP is an investment fund that allows contributions to grow tax-free until they are withdrawn at retirement at a reduced marginal tax rate. Additionally, the plan members can save funds by contributing when their earnings are taxed higher. You can head to Alpine Credits for more information.

Early RRSP Withdrawals May Cause Lifelong Regret

Early withdrawal from RRSP funds can limit the money from growing in investments over time. They may even result in a higher tax burden if your income remains the same. 

It gets worse from here. Withdrawals from an RRSP made by someone under 65 are subject to a 30 percent tax. Withdrawals above $15,000 are subject to the maximum withholding tax. The rate is lower for those who live in Quebec.

You will likely pay more than 30 percent withholding tax if an RRSP withdrawal raises your marginal income tax rate above 30%. When you withdraw funds from your RRSP early, you forfeit the ability to contribute in future years with increasing income.

When to Take an Early RRSP Withdrawal?

You can consider shelling out withholding tax for early withdrawals if you have lost income and hence have a lower marginal tax rate. However, you might expect a refund when you file your taxes.

Other than the withholding tax, withdrawals from an RRSP are taxed at the rate applicable to the previous year’s income, irrespective of age. It could be the support you require to get through difficult situations. Additionally, you can avoid paying taxes on the earnings if they are used to buying the first house or returning to school.

How to Withdraw From an RRSP without Penalties?

There are two ways to withdraw money from an RRSP without penalty: the (HBP) Home Buyers’ Plan and the (LLP) Lifelong Learning Plan.

1. The Home Buyers’ Plan (HBP)

The Home Buyers’ Plan (HBP) allows first-time homebuyers to take up a one-time loan of up to $35,000 to use as a down payment on their first home. Previously, this threshold was $25,000, which was increased in 2019.

The tax-free withdrawal must be repaid in full within 15 years. Funds must also be held in an RRSP for 90 days before being withdrawn for the HBP. The funds are available for usage for 30 days after you have finalized the acquisition of your home or taken possession of the property. As a result of the withdrawal rules, you must make an annual payment to your RRSP.

2. The Lifelong Learning Plan (LLP)

If you want to return to school and complete or improve your education, this Educational Plan is for you. Your four-year tax-free withdrawal limit under the Lifelong Learning Plan is $20,000, with a maximum of $10,000 every calendar year. You or your spouse/common-law partner can use the plan to enroll in a full-time program. However, children are excluded.

You have ten years to recover your LLP withdrawal if you follow the withdrawal rules. After that, you’ll be required to repay 10% of your total withdrawal each year.

Rules Regarding Spousal RRSP Withdrawals

Spousal RRSPs function similarly to normal Registered Retirement Savings Plans. The owner (annuitant) is your spouse/common-law partner, even if you contribute. The objective is to take retirement income from the spouse who pays less tax. The ultimate objective is to assist in reducing tax burdens.

Withdrawal Guidelines for Locked-In Retirement Accounts (IRAs)

LIRAs, like RRSPs, are a form of registered account. If you are fortunate enough to receive a pension and leave or are laid off, your pension is transferred to a LIRA. Since you can’t make any additional contributions to the LIRA, it acts as a convenient locker for your retirement savings.

LIRAs must be converted to a Life Income Fund (LIF) for taxable retirement income. You must complete this conversion before the end of the year in which you turn 71 to begin taking withdrawal the following year.

Alternatives to RRSP Withdrawals

• Experts advise that you always maintain an emergency fund if your income hasn’t changed. When it comes to real life, it’s not a good idea to keep money in the bank to generate profits.
• Savings bonds and other non-registered assets, such as (GICs) guaranteed investment certificates, may be a realistic option in a financial crisis. Even though these investments will suffer a loss, there is no tax-sheltered advantage at risk.
• If you have many debts, consider consolidating them into one low-interest loan.
• A (TFSA) Tax-Free Savings Account is a good option if you want to save money for the short term. Contributions to a TFSA are not tax-deductible like contributions to an RRSP, but withdrawals and earnings are never taxed. Make sure to keep track of the contribution limits.
• Credit card debt, which typically carries a high-interest rate, should be avoided. You can avail of convenient, low-cost consumer loans from most banks.
• An even better option is to leverage the value of your property to develop a secured credit line that you may access at any time. Home equity lines of credit (HELOCs) often have the lowest interest since they are backed by the equity in an owner’s home.
• Using your bank account as a cash point has risks as well, and if performed regularly enough without repayment, it can become crippling burdens later in life.

Bottom line

If you need money before you retire, you might be better off taking out a line of credit from your home. For example, if you have accumulated a significant amount of equity in your house, you may be eligible for a low-interest home equity line of credit. It may be a better option for a taxable RRSP withdrawal.

It is best to consult an RRSP expert who can guide you about scheduling your withdrawal for maximum tax benefit.