Does it ever make sense to withdraw early from an RRSP?

In the first few months of every year, there tends to be a focus on RRSPs due to the contribution deadline that usually runs 60 days into the new year. People are looking into how best to max out their contribution, but is there ever a time to take money out of your retirement account?

Note that RRSP contributions reduce your taxable income. This means taxes on those contributions are deferred until you make a withdrawal; at this point you will be taxed at your marginal tax rate. Whilst this can mean substantial tax savings, some might worry about saving for retirement that could still be a long time away.

It’s a valid concern, and in some situations withdrawing from your RRSP before retirement can work in your favor. These are the most common situations:

Buying a house

If you haven’t lived in a house you owned in the last four calendar years, you could withdraw up to $60,000 to use as a down payment through the Home Buyer’s Plan (HBP). There are no tax implications as long as the money is paid back by the deadline, usually in 15 years.

It would be worth considering a First Home Savings Account (FHSA) or a standard savings account as first option though. If withdrawing from a tax-advantaged account, selecting a RRSP before a TFSA has benefit. This is because any money left in a TFSA is considered more valuable than money left in an RRSP. In a TFSA, money will compound tax-free and is eventually tax-free when withdrawn.

The HBP can be a smart move though. It could help avoid mortgage insurance that is required when borrowing more than 80% of the house’s value. Reducing monthly housing costs using taxed dollars can be considered a form of tax-saving!

For education or training

The Lifelong Learning Plan (LLP) lets you withdraw up to $20,000 from your RRSP to cover tuition or other education expenses. Whether it’s for college, university or professional development, there are no tax implications if you pay back the money within 10 years.

During times when income might be an issue

It must be noted that early RRSP withdrawals are taxed at your current marginal rate; they are not penalized. Should you take a career break or parental leave, or lose your job, your marginal rate would drop. In such an instance, withdrawing from an RRSP could be beneficial. There is no limit on the amount you withdraw, but the more taken the more you will be taxed; and so less set aside for retirement.

Easing into retirement

When approaching retirement, some might take on part-time work which wouldn’t pay as much as their previous jobs. With income reduced and perhaps being too young to receive pension, a RRSP withdrawal could be used as additional income.

It’s worth noting at age 71, a RRSP must be converted to a Registered Retirement Income Fund (RRIF) that mandates annual withdrawals. If your RRSP balance is large, the forced withdrawals may mean you go into an income bracket that is high enough to warrant government benefits being deducted e.g old age security.

Note in this instance, a RRSP withdrawal before retirement could be a strategic move by putting the money into a TFSA. It wouldn’t count as income and may help with your tax rate over time.

Reducing taxes on your estate

If you don’t designate your RRSP or RRIF to your surviving spouse or common-law partner, the CRA will tax the remaining funds in the year you die. It would be common that there is enough money in the account that the top marginal rate could be applied. Withdrawing from your RRSP could be another strategic tactic to reduce your estate taxes.

There is one very important consideration when making early RRSP withdrawals: with exception of HBP or LLP, any withdrawal reduces your contribution room which you don’t get back. This impacts your opportunity for tax-sheltered compounding of investments which can affect your retirement. It is always best to consult with a financial advisor to consider the implications before making an early withdrawal.