Avoid costly mistakes: A guide to RRSP withdrawals for Canadians

Registered Retirement Savings Plans (RRSPs) are a popular way to save and invest toward your retirement, but there comes a time when you are required to start making withdrawals to fund your retirement. You can only contribute to an RRSP until December 31 of the year you turn 71, at which point you have to convert your RRSP into a Registered Retirement Income Fund (RRIF) or withdraw all the funds. There are no rules preventing you from dipping into your pool of money before then, but should you?

Although RRSPs are designed to give Canadians a way to grow their money tax-deferred for retirement, there may be legitimate reasons you might need to withdraw funds before you retire. For instance, you might want to use some RRSP cash to fund a down payment on a home, help out a family member in need or clear up some lingering debts.

While there are some tax-efficient ways to draw on your RRSPs outside of retirement, most of those withdrawals come with a hefty tax bill, since these amounts are added to your taxable income for the year. That’s why it’s critical to understand how a withdrawal will affect your taxes before you make any moves. This guide will help you understand your options and their tax implications.

Early RRSP withdrawals: What you need to know before 71

RRSPs are designed for retirement, so the government discourages early withdrawals by adding them to your gross taxable income for the year.

For example, if you earn $64,000 and you withdraw $80,000 from your RRSP, the Canada Revenue Agency (CRA) will consider your gross income to be $144,000 that year, which would push you into a higher tax bracket. Not only would that eliminate the value of the tax credit you received when you made your contribution, but the money would also be taxed at a higher rate than if you hadn't contributed.

Depending on what you take out, your tax bill could be significant, and for those not used to paying the CRA directly (most people have their taxes deducted from each paycheque), it can be challenging to figure out how much to set aside for taxes on that withdrawal.

That’s why the government takes a withholding tax off the amount you withdraw from your RRSP. You’re paying the government its share of income tax in advance, so you don’t end up spending the money. (Even with the withholding tax, it may not be enough to cover what you owe.)

This RRSP withholding tax varies depending on how much you withdraw and your Canadian residency status. Here are the most recent rates for Canadian residents:

For non-residents of Canada, there is a flat taxation rate of 25% on all RRSP withdrawals, unless there is a treaty in place with the country of which you are a citizen that reduces the rate. 

Exceptions to RRSP withdrawal taxes: When can you take money out tax-free?

There are a few exceptions that allow you to withdraw funds without facing withholding tax.

1. The Home Buyers’ Plan (HBP)

If you are buying your first home, the HBP allows you to make a tax-free withdrawal of up to $60,000 from your RRSPs to purchase or build a qualifying home for yourself or a qualified disabled person. The caveat is that you must repay the amount you withdrew from any RRSPs within 15 years, and the repayment period starts the second year after the year of your first withdrawal. For withdrawals between January 1, 2022 and December 31, 2025 the repayment period would start the fifth year following the year in which the first withdrawal was made. If you don’t pay all the money back, the remaining amounts will be added to your taxable income.

2. The Lifelong Learning Plan (LLP)

With the LLP, you can take out up to $10,000 per year, with a lifetime maximum of $20,000, to pay for full-time education or training for yourself or your spouse/common-law partner. You can withdraw money to cover four years of learning (not necessarily consecutive ones). You must start repaying the money within five years of your first withdrawal, and then have up to ten years to complete repayments. 

3. RRSP transfer to another RRSP

There’s one other exception to the RRSP early withdrawal rule: you can transfer funds to another RRSP, but you’ll need to ask your financial institution to initiate the transaction. If you withdraw the funds yourself and redeposit them into another RRSP, it’s considered a qualifying withdrawal, and you’ll be taxed on the amount. You will also lose the contribution room for the amount withdrawn.

RRSP withdrawals after 71: What you need to know

At the end of the year you turn 71, you can no longer contribute to your RRSPs, and you must decide what to do with your (or your spouse’s) savings.

1. Transfer the funds to a RRIF account.

Rolling the money into a RRIF is the most popular option. While your RRSP issuer will not withhold tax when you convert your RRSP to a RRIF, you will have to pay tax once you begin making monthly withdrawals for retirement income.

2. Withdraw the funds from your RRSPs.

This option is less favourable, due to the tax implications. Just like when you withdraw money from your RRSPs early, withdrawing the money after you turn 71 will be a taxable event. If you choose this option, you will be taxed on the entire amount, resulting in significant tax-owing.

If you want help figuring out which option is right for you, be sure to speak with your financial advisor.

The bottom line 

Before tapping into your RRSPs early, think about your reasons for withdrawing and whether the tax trade-off is worth it. If money is going to be used to further your education or to purchase your first home, you may have withdrawal options. If you need flexible access to your money before retirement, you may consider directing some savings to a Tax-Free Savings Account or non-registered account.

It’s important to maximize the benefits of your RRSP and minimize withdrawals before retirement, allowing your money to grow over the long-term.