There are many reasons for pulling money from your RRSP, buying a home, going back to school, retirement, emergencies, etc. In previous videos, I’ve outlined how you can do that to purchase your first home or go back to school. Today, I’ll discuss other reasons why you might pull money out of your RRSP and how that works.
The first reason why you might pull money out of your RRSP is if you’ve made an over contribution. You’re only allowed to put a certain amount of money into the RRSP based on your personal contribution room according to the CRA. You might be in the position where you’ve put in more than you’re allowed. I would suggest avoiding this as much as possible because if you put more than $2,000 extra into your RRSP, you’re charged a steep penalty by the CRA, 1% per month on the excess contribution. But hey, mistakes happen, so it’s not the end of the world if you’re in this situation. If it does happen, you can submit a request to your financial institution to withdraw the excess contribution without having to pay a withholding tax (which I’ll talk about in a minute), by completing CRA form T3012A. There’s a link to this form in the description below. You’ll also want to submit a Request for Taxpayer Relief to Cancel or Waive Penalties or Interest form and explain why you shouldn’t have to pay the 1% penalty – that it was a reasonable mistake, and you have withdrawn (or are in the process of withdrawing) the excess contribution. By doing these two things, you’ll hopefully remove the amount you over-contributed to your RRSP with little penalties or taxes owed. Alternatively you can simply pay the penalty and move on.
A second reason why you might pull from your RRSP is to use that money to pay for emergencies or pay off debt. This is rarely a good idea, because you’ll be taxed on the income you pull from the RRSP. Depending on how much you pull from the account you’ll initially be hit with a withholding tax. This withholding tax depends on the amount you withdraw. Withdrawals up to $5,000 incur a withholding tax of 10%. Withdrawals between $5,000 and $15,000 incur a withholding tax of 20%, and withdrawals over $15,000 incur withholding taxes of 30%. For example, let’s say that you want to buy a boat for $20,000, and want to use funds from your RRSP. If you withdrew $20,000 from your RRSP, you’d only get $14,000 in your pocket. $6,000 automatically goes to the CRA for taxes. If you needed $20,000 in your pocket, you’d have to withdraw about $28,570. This is the automatic withholding tax you owe, but isn’t necessarily the tax you owe on the funds. If you are in a tax bracket that’s higher than 30%, you’ll owe even more tax at tax time, if you’re in a lower tax bracket, you might get some of that tax back. This is because RRSP withdrawals are taxed as regular income, and are therefore taxed at your marginal tax rate.
For example, someone earning $30,000 per year in Ontario is currently in the lowest tax bracket at 20.05%. A $20,000 withdrawal from the RRSP will bump them into a higher tax bracket, but it’s still less than 30%, what they’ve already paid in taxes. They’ll actually get $1,444 back at tax time. Someone earning $80,000 has a tax bracket above 30% tax bracket, and withdrawing $20,000 would bump them into an even higher tax bracket, and they would owe additional tax of $1,622 on the withdrawal at tax time.
| $30,000 Earner | $80,000 Earner | |
| RRSP Withdrawal | $20,000 | $20,000 |
| Total Income | $50,000 | $100,000 |
| Tax Owing on Withdrawal Based on Total Income | $4,556 | $7,622 |
| Tax Paid Through Withholding Tax | $6,000 | $6,000 |
| Tax Owing at Tax Time | -$1,444 | $1,622 |
This is why pulling from your RRSP for spending is a terrible idea. Any spending should be within your ability to pay for it through your regular income, or ongoing savings that have been set aside for that spending. You also shouldn’t be tapping into your RRSP for emergencies either. For emergencies, an emergency fund should be set up, or at least have access to a Line of Credit so that you don’t have to pull valuable retirement savings to fund emergencies and get penalized. You don’t get your contribution room back when you withdraw, meaning that unlike the TFSA, any withdrawals you make from your RRSP can’t go back in at a later date. So pulling from your RRSP, especially if you’re maxing it out (or plan on maxing it out in the future) reduces the amount of retirement savings you’re able to shelter from taxes.
Similar to the previous case, pulling money from your RRSP for retirement income is taxed at your marginal tax rate. However, since many people are in a lower tax bracket in retirement than they were when they contributed to the RRSP as their income needs are less: they don’t need to save for retirement, their mortgage is paid off, children are out of the house, there are tax benefits for senior retirees, the tax paid on withdrawal is less than the tax benefit gained on contribution. For more information on this, see my video “Rethinking RRSP’s”. If you’re pulling from the RRSP during retirement, a withholding tax still applies. What the vast majority of people do is convert their RRSP to a RRIF (registered retirement income fund) either at retirement, or when their required to wind-up their RRSP’s at age 71. The RRIF can eliminate some or all of the withholding tax on withdrawals.
In summary, withdrawals from RRSP’s are taxed at your marginal tax rate, and incur withholding taxes between 10 and 30%. If you overcontribute to your RRSP and make a withdrawal to fix it and remove the excess, you can avoid the withholding tax, and can potentially avoid penalties if you ask CRA nicely. These taxes on withdrawals aren’t necessarily a bad thing though, if it keeps you from raiding your RRSP for expenses not related to retirement!
