Tapping your RRSP early has pros and cons
If you're short on cash in your bank account, but long on money
inside your RRSP, don't despair. There are instances when you can
borrow from your RRSP without taxes gobbling up your hard-earned
Normally, when you withdraw money from an RRSP, you
pay a withholding tax, which can be as high as 30 percent, depending
on the amount you remove. Moreover, the amount you withdraw must
be claimed as income in that year and is taxed at your marginal
rate. So the amount you withdraw can evaporate quickly.
However, the federal government has two programs through
which you can make tax-free withdrawals, provided you meet certain
conditions and repay the money on time.
The Home Buyers' Plan helps first-time buyers buy
or build a home, while the Lifelong Learning Plan lets people tap
their RRSPs for educational purposes.
But before dipping into your hard-earned nest egg,
"there are definitely some things people need to think about,"
says Lisa Ball, regional manager of Bank of Montreal Mutual Funds
in Halifax, N.S.
When you remove money from your RRSP, it is no longer
tax-sheltered and that must be weighed against the benefits of furthering
your education or owning a home, says Ball. She says borrowers could
find their "RRSP may be significantly less at retirement ...
by withdrawing a large chunk now."
The Home Buyers' Plan
Under the HBP, individuals may borrow as much as $20,000 from their
RRSP. It can be in a single payment or a series of withdrawals throughout
the year. If you are buying a home with someone else, he or she
can also withdraw as much as $20,000 from his or her RRSP.
Each person must repay the entire amount within 15
years, at a rate of 1/15th per year, or $1,333 a year if you withdraw
the maximum. Repayments start the second year after you make your
withdrawal, so the $20,000 must be paid back within 17 years of
its leaving your RRSP. If you fail to make the payments, that amount
must be claimed as income on your tax return that year.
In order to qualify for the program, you must meet
the following requirements:
- you must be a Canadian resident
- you cannot have previously owned a home for at least five years
- you must enter into an agreement to buy or build a home, and
- you must intend to occupy the home as your principal residence.
Bill Anderson, senior manager of financial planning
and investment savings at Scotiabank in Toronto, says "the
Home Buyers' Plan is getting more attention all the time, because
it is a quick way to help you save for your down payment."
But the money doesn't have to be used for that purpose. It can also
be used to renovate the home you buy.
Calculating the long-term impact of removing $20,000
from your RRSP is no easy task, because it must be weighed against
what you gain from buying a home, says Patricia Lovett-Reid, senior
vice president at TD Waterhouse Canada in Toronto.
A $20,000 investment earning 7 percent in an RRSP
would be worth $63,176 after 17 years. If you borrowed
that amount and paid it back at the 1/15th per year rate of $1,333
a year, then at a 7 percent rate of return, it would be worth
only $33,497, a difference of $29,679.
However, you must also consider whether your home
will appreciate in value and by how much. If it increases substantially
over that time, you could be further ahead.
As well, if the money was used as a down payment and
allowed you to qualify for a cheaper mortgage, those savings must
also be factored into the equation. For example, if you have less
than 25 percent to put down on a home, then you must use a high-ratio
mortgage, which can add thousands of dollars to your mortgage costs.
Lovett-Reid says borrowing from your RRSP is a great
strategy if it helps you top up your down payment to qualify for
a cheaper mortgage. For up-to-date mortgage rates, click
Before borrowing, Ball says home buyers have to be
able to sustain the cash flow to repay the RRSP. Since the rules
about withdrawing from and repaying your RRSP are intricate, you
have to know what you're doing.
For example, some buyers might hold their down payments
outside their RRSPs and then decide to put them into their RRSPs
to get the tax refunds and then withdraw them shortly thereafter.
It's a good idea, but, Bell warns, do your homework first: The Canada
Customs and Revenue Agency has rules that could affect the deductibility
of contributions made in the 89-day period prior to the withdrawal.
The Lifelong Learning Plan
Lovett-Reid says in today's rapidly changing world, workers change
careers at least five times in their lifetimes. So, the Lifelong
Learning Plan could be the ticket to finding a new job if you are
laid off or need a change. According to the government, more than
41,000 Canadians have used the plan, withdrawing $275 million.
Under the LLP, you can withdraw as much as $20,000
from your RRSP to pay for full-time training or education at a qualified
institution for you or your spouse. You cannot borrow from your
RRSP to pay for your children's education.
To qualify you must:
- be a Canadian resident
- have an RRSP, and
- be enrolled or accepted at a qualified educational institution
as a full-time student. The program must last three consecutive
months or more and require students to spend 10 hours or more
per week on course work.
You can withdraw as much as $10,000 per calendar year
and the money doesn't have to be spent on tuition. It can also be
used for living expenses.
Armstrong says the LLP works in a fashion similar
to the Home Buyers' Plan.The amount withdrawn must be repaid over
10 years at 1/10th per year, commencing the fifth year after your
first withdrawal. BMO's Ball says if you fail to complete your courses,
repayment commences automatically within 60 days.
Ball says it's difficult to determine the impact on
your RRSP versus the benefits of a higher education. "Hopefully,
you're not taking out too much," she says, adding that people
usually pursue more education to get a higher income and therefore
can contribute more to their retirement savings afterward.
Armstrong says the two plans are "tools that
should be considered when looking at all your options. It's going
to depend on your personal situation whether it fits your needs
Jim Middlemiss is a freelance
writer and lawyer based in Toronto, Ontario. He's a frequent contributor
to National Post, Investment Executive and Wall Street and Technology.