Are you considering withdrawing funds from your RRSP? Make sure you understand your options before you do so.
As a rule of thumb, it generally is not a good idea to withdraw funds from your RRSP unless you absolutely need the money, or your income is relatively low compared to what you expect it to be in the future. Withdrawing funds from your RRSP today does not help your retirement plan in the future, and should you choose to ‘re-contribute’, those contributions reduce your contribution room.
Your withdrawal options give you quite a bit of flexibility. However, if the funds were originally transferred in from a pension plan, you likely have a locked-in RRSP and those funds are subject to withdrawal restrictions.
Quite simply, withdrawals are fully taxable in the year received. This applies to withdrawal of funds that are either your original principal contributions or the income earned on that principal.
When to withdraw?
In most cases, it is best if you wait until you are 71 years of age. This allows you to take advantage of the tax deferral RRSP’s offer for as long as possible.
Other than 71, another popular time is 65 years of age. Doing so may allow you to take advantage of the pension tax credit if you do not already have other eligible pension income. Generating eligible pension income may allow you to experience immediate tax savings by splitting up to 50% of your pension income to your spouse, assuming they have less income than you. However, it is not that straight forward, as you need to consider other credits that are affected by your level of net income.
How to withdraw?
You basically have three options:
1. Collapse and withdraw
2. Purchase an annuity
3. Transfer to a RRIF
Collapse and withdraw
Should you choose to essentially collapse and withdraw the funds in entirety, the withdrawal will be taxed in full, in your hands, during that year. This will likely trigger quite a bit of tax, however, the issuer will withhold an amount (dependent on the amount of the withdrawal).
Purchase an annuity
Purchasing an annuity essentially entitles you to periodic payments, for your life or for a fixed number of years. You do have several options and the amount of the annuity payments is dependent on several factors. For example, you can strategically choose to receive payments until the later of your death or your spouse’s death. Obviously, the longer the length of time you choose to stretch out the payments, the lesser the payments will be.
Annuity payments are considered pension income and they are usually purchased from an insurance company.
Advantage? Income to you is guaranteed for a known period of time.
Disadvantage? Your purchasing power is at risk due to inflation.
Transfer to a RRIF
A RRIF is extremely similar to an RRSP, with two major exceptions: contributions cannot be made to a RRIF; and, a minimum amount must be withdrawn each year.
RRIF’s are a great vehicle because they allow you to maintain the same investments you maintained in your RRSP. They also allow you to keep the account as self-directed if you that is your preference.
The minimum amount required to be withdrawn is dependent on the fair market value of the plan on January 1 of each year. Although there is a minimum amount, you are entitled to withdraw more than the minimum if you wish.
Often a missed opportunity is to use your spouse’s age in calculating the minimum withdrawl amount. This is of course only advantageous (as it gives you further tax deferral) if your spouse is younger than you.
Advantage? You can maintain control compared to an annuity.
Disadvantage? Your investments may not perform as well as you need them to to provide the funds you desire.
Before withdrawing funds from your RRSP, be well aware of your options. Think through both short-term and long-term implications.
