How RRSP Withdrawals In Canada Works!

When you withdraw money from your rrsp, you've ultimately interrupted the compounding of your money. When it comes to withdrawing money out of your rrsp, there are a couple of exceptions that exist for you, and the government recognizes some of these exceptions. The government has given very specific rules in how the withdrawal needs to work for specific purposes, and they've also given specific rules of how it needs to be repaid.

So when it comes to your rrsp, depending on what stage you're in, you may often overlook the withdrawal aspect of the rrsp. And most of the time, since you're spending your time and attention focusing on saving a portion of the income you earn into retirement and, and then growing that income in the rrsp, well, there will be a time where you may need to access and tap into the money that you've saved into your rrsp. When you do, unfortunately, some potentially significant consequences to you when you withdraw money from your rrsp. The first, and not so obvious one is that when you withdraw money from your rrsp, you've ultimately interrupted the compounding of your money. And let's use an example. If you had $1 million in your RRSP, and let's assume you've earned an actual annual return of 5%, you've received 50,000 growth in your RRSP. Well, if you had to withdraw $100,000 from that $1 million portfolio, you now have $900,000. And if we assume you receive the same actual return, you're now going to receive 45,000 as a return or increase in your portfolio instead of the 50,000. So you've lost 5,000 in growth because of that withdrawal. The second consequence to be aware of is when you contribute to an rrsp, it's going to result in a reduction in in your taxable income, therefore it could affect your tax bracket. And therefore you'll pay less taxes because you're in a lower tax bracket because of a lower taxable income. Well, when you withdraw money from your rrsp, it will increase your taxable income for the year that you withdraw it, which could possibly move you into a higher income tax bracket and therefore attract a higher tax rate. The third nuance that you may not be familiar with is the timing of the taxes that you would pay on that withdrawal. Now, different rules apply for Quebec, but generally across Canada, when you withdraw money from the financial institution that holds your rrsp, they will immediately remove a percentage from that withdrawal, called withholding tax. The amount of withholding tax that the financial institution will withhold will depend on the amount that you withdraw. So if the amount that you withdraw is 5,000, then the amount of tax that would be withheld right away would be 10%. If the amount you are withdrawing is over 5,000 up to including 15,000, then the amount being withheld from that withdrawal will be 20%. And if the amount is over 15,000, then the amount of tax that would be withheld would be 30, 30%. And so let's walk through an example so that I can help illustrate this point. So when it comes to withdrawing money out of the rrsp, it's going to be considered as other income. And when it comes to other income, you will get taxed at a different tax rate. And again, if you use one of the income tax calculators, that that will show you what that looks like. So let me just kind of quickly walk you through that example. So again in front of you you see a income tax calculator and the section that you would fill out is over here, $100,000. And I'm just using a hypothetical example again. So of $100,000, it's not employment income, it's not self employment, it's not capital gains and so forth. It's actually other income. And when you're taking money out of the other income, the total taxes you would Pay would be 24,205, which is primarily from the federal tax and the provincial tax. So your tax rate Approximately is about 24% of that income. So now if I take the same example and show on Excel now, the amount that I'm showing you is $100,000, which is greater than the $15,000. So therefore the withholding tax of 30% is going to apply. So when we look at 30% of the $100,000, that's going to be $30,000. So immediately what you're going to receive, and let's assume you withdraw that cash out on January 1st, 1st of the year and of January 1st, what you are actually going to receive from financial institution which your RRSP is at, you're only going to receive $70,000. Of that $70,000. If we kind of go back to the calculator that you see here, the way that you can now follow and trace this through is that the tax that you actually should have paid is 24,205. So you actually should be paying 24,205. And if you withdrew the money on January 1st, so what you received was actually 70,000 instead of the 100,000, well, when you file your annual tax return, if this is the only income source you receive. Again, this is theoretically speaking.

When you will get reconciled and be made whole by April 30, if that's when you file your personal tax return. So then if so then you would receive a 5795 income. Again, the actual result will differ based on other circumstances that you have personally. And you will only know that once you go through filing your actual final return. The key point that I want you to take away is immediately when you withdraw $100,000, 30,000 is going to be taken from the the financial institution as withholding tax. And then after you're going to receive actually $70,000 and everything gets made whole and reconciled by the end of next year. So the following April 30, not the same year as that, as the January 30. So in 2021, when you file your tax return by April 30 of 2022, you then you will get that repayment of taxes that was initially over withdrawn, withheld from the financial institution. So for some people this can actually make a very big difference or it's a very big surprise for some people when it comes to that timing. When it comes to withdrawing money out of your rrsp, there are a couple of exceptions that exist for you and the government recognizes some of these exceptions. Now I'm going to explain some of the more popular exceptions when it relates to accessing money in your rrsp. And I think it'll be important for you to understand and see whether or not these exceptions to the withdrawal from the RRSP actually make sense for you in the context that you're in a very popular program when it comes to withdrawing money out of your RRSP that people let that you may know about is called the Lifelong Learning Plan. And in order for the Lifelong Learning Plan to be used, the contribution to the RRSP must be created within 90 days. You are able to withdraw up to $10,000 per calendar year from your RRSP to finance full time training or education without triggering taxable income. When you withdraw from the RRSP for a lifelong learning plan, you will receive what's called a T4 RSP form which will show these specific withdrawals. Now, there are specific conditions that have to be met in order for you to be able to withdraw it. And one of those conditions include being enrolled in a qualifying educational program. The maximum withdrawal limit without triggering taxable income is $20,000. And when you make these withdrawals, you have to repay these amounts in no less than 10 years. So if you look at this lifelong learning plan, in the context of the education that you're going through, is $10,000 annually enough for the tuition that you would have to pay, number one, and is $20,000 enough for your qualified education when, when you use that? Otherwise, the amounts that have not been repaid would be included in your income. When it comes to withdrawal, this is one of the exemptions that you have when it comes to using it for a specified purpose. The second exemption that exists with withdrawals relates to what's called the home buyer's plan. And this is used for buying or building a home where you did not own a home four years prior to meeting access to the contribution to your RRSP. Now, this amount of money that's in your RRSP must be, must have been created within 90 days. And similarly, a form must be filled out and you will be able to access 35,000 without triggering taxable income when it's withdrawn. The form is called a T4 RSP form, and it'll show these withdrawals. Now, the caveat to this withdrawal is that when you do this $35,000 withdrawal, it must be repaid over 15 years and starting no later than the second following year in which you have made that withdrawal. When you file your taxes every year, you must repay that back to the RRSP, or 115 of the amount will be included in your income for tax purposes. So very similarly, when we look at this withdrawal exemption that's available, 35,000 would be able to be used for your home when you were to purchase it. It's important to take a look at the current circumstances that we're in, and if we look at current home prices, $35,000 may not be enough for purchasing the home that you're looking for. So you have to wonder whether or not, when we look at the context of these exemptions, the Lifelong Learning plan and the Home Buyer's plan, the government has given very specific rules in how the withdrawal needs to work for specific purposes, and they've also given specific rules of how it needs to be repaid. They are the one in control of how you use your money that you've initially stowed away for retirement.