Luisa Rollenhagen is a journalist and investor who writes about financial planning for Wealthsimple. She is a past winner of the David James Burrell Prize for journalistic achievement and her work has been published in GQ Magazine and BuzzFeed. Luisa earned her M.A. in Journalism at New York University and is now based in Berlin, Germany.
An RRSP is a great savings option for Canadians looking to put away money for retirement. Paying into an RRSP allows you to put your money into a wide variety of investments—such as mutual funds, ETFs, and stocks—and offers some important tax benefits: While the investments stay in the RRSP, you don’t pay income tax on any interest, dividends, or capital gains you earn. Plus, the money that you regularly contribute to an RRSP is considered “pre-tax,” meaning that you can subtract the amount you contribute from your income and pay less in income taxes.
How much is the RRSP withholding tax rate
But imagine this: You’re 45, so nowhere near retirement, and suddenly something happens: the roof of your house collapses, you unwittingly sunk all your savings into a pyramid scheme, you were the victim of an elaborate online dating site fraud involving a fake Belarusian prince—whatever. And now you need money, asap. So you decide to withdraw early from your RRSP. Well, that’ll come at a cost. When you withdraw from your RRSP before retirement, you’ll be charged what’s known as a withholding tax, which will be withdrawn from your account directly by the financial institution where you have your RRSP. That amount then goes directly to the government.
RRSP withholding tax is charged when you withdraw funds from your RRSP before retirement. The current rate of RRSP withholding tax is 10% for withdrawals up to $5000, 20% for withdrawals between $5000 and $15000, and 30% for withdrawals over $15000.
The tax rate depends on how much you withdraw and where you reside. If you are a resident of Canada, the withholding rates are as follows (as of publication):
|Withdrawal Amount||Up to $5,000||Between $5,000 and up to $15,000||Over $15,000|
|Rate of tax withheld for Canadian residents||10% withheld||20% withheld||30% withheld|
|Rate of tax withheld for the province of Québec||5% withheld||10% withheld||15% withheld|
(Residents of Québec also pay a provincial sales tax of 16% in addition to the federal withholding tax. If you are a non-resident of Canada, you will pay a 25% withholding tax rate, regardless of the size of the withdrawal)
It’s also important to keep in mind that this won’t be the only time you’ll be taxed: The amount you withdraw will count as income, so you’ll have to declare it once you do your tax declaration for the year that you’ve withdrawn. If the withdrawal ends up putting you in a higher tax bracket, you’ll have to pay more income tax, since the withdrawal tax likely won’t cover the full amount of income tax you’ll owe. That’s why withdrawing prematurely from an RRSP should really be a last resort, after you’ve exhausted all other possible avenues.
When you withdraw from your RRSP, your financial institution will provide a T4-RRSP showing the amount you withdrew, and how much tax was withheld. You must declare this amount on your T1 General Income Tax Return in the calendar year you withdrew it. You can find the income tax rates for the current year on the Canada Revenue Agency (CRA) website.
Another important consideration: You don’t get your contribution room back. The Canada Revenue Agency only lets you count that contribution once — you can’t add back the amount of a withdrawal to existing contribution room. So if you take out $7,000, you won’t be able to add it back in later. That means you’ll decrease the amount of money in the account that would benefit from compounding.
How to avoid withholding tax when withdrawing RRSP funds
Is there any way to prematurely withdraw from an RRSP without incurring the punishment of the CRA? There are actually two exceptions where early withdrawals from an RRSP won’t incur withholding taxes. These are withdrawals made under the Homebuyer’s Plan (HBP) and/or the Lifelong Learning Plan (LLP).
Homebuyer’s Plan (HBP)
The Homebuyer’s Plan is a program that allows you to withdraw up to $25,000 (tax-free) in a calendar year from your RRSP in order to buy or build a home. You have 15 years to pay the funds back and repayments start the second year after you withdraw the funds. CRA will send you a statement each year with your HBP balance owing, payments made to date, and what the minimum payment amount is. In order to participate in this program, you’ll have to fulfill certain criteria, including demonstrating that you’re a first-time home buyer.
Lifelong Learning Plan (LLP)
Participants in the Lifelong Learning Plan are allowed to withdraw up to $10,000 tax-free per calendar year from an RRSP, subject to a maximum combined total of $20,000 tax-free to finance full-time education or training for you, your spouse, or your common-law partner. You don’t have to withdraw the full amount at once, and can instead spread it out over four years, as long as you don’t exceed $20,000.
You have 10 years to pay back the funds, starting in the fifth year after your first LLP withdrawal. CRA will send you an LLP notice each year with your LLP balance, payments made, and the amount of your next LLP payment. You still have to file income tax each year and designate your LLP repayment on Schedule 7.
Consequences of withdrawing RRSP money early
The biggest consequence of prematurely withdrawing RRSP funds early is certainly the tax penalties. Your tax bill can really suffer, especially if you withdraw a large amount, since in addition to the withdrawal taxes you’ll also be paying combined income tax.
But another huge consequence of withdrawing funds early? The simple truth is that you’re just robbing your future self of money you’ll need in retirement. An RRSP works its magic when longterm, steady contributions allow funds to grow thanks to the magic of compounding. Withdrawing funds is a huge setback for the progress of your retirement fund, especially since you won’t be able to recuperate the contribution room you’ve lost through early withdrawal.
Keep in mind that withdrawing multiple smaller amounts in a short period of time in an attempt to avoid the higher withholding tax comes with certain disadvantages as well. Your financial institution could still deduct the amount of withholding tax that would apply to the total amount. For example, if you want to withdraw $10,000 but you split it into four monthly withdrawals of $2,500 to avoid the 20% tax withholding rate, your financial institution could still withhold 20% on the last withdrawal if they notice the pattern. The point is: Withdrawals are generally not advisable and you should be exploring other possible avenues before you touch your RRSP.
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