February 25, 2008, 7:00 am

The Drawbacks Of Withdrawing From Your RRSP Before Retirement

by: The Financial Blogger    Category: RRSP
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One day or another, you will have to take your money out of your RRSP account. However, there are several drawbacks of doing it before retirement. Sometimes, you simply have no other choices but use this money but I still think it would be good that you know all the consequences before doing such thing.




Hurting your retirement plan

The first impact of making early withdrawals is obviously that it will affect your retirement plan later on. If you leave your $15,000 in your RRSP account for 20 years at 7%, you would get $58,000. This represents $39,000 in today’s dollar (considering a 2% inflation rate). Therefore, taking $15,000 out of your RRSP account today means losing $24,000 if you plan to retire in 20 years.


Getting taxed right away

Whenever you withdraw money from an RRSP account, the financial institution will take a provision for taxes before giving your money. It is usually around 21%. Therefore, by taking 15k, you will only get $11,850. In addition to that, you will have to add 15K to your year end income when you fill in your tax report. Hence you will end up paying more taxes if your marginal tax rate is over 21% (which it probably is!).


You cannot put this money back in your RRSP account

Another severe consequence of withdrawing from your RRSP’s is that you cannot put this money back in. You are allowed to contribute a certain amount per year according to your income and once it is done, you cannot contribute again in order to “reimburse your RRSP account”. This means that a part of your investment may not be tax sheltered at one point in time.


Ways to get around this

Fortunately for us, there are two programs that allow us to withdraw money from our RRSP without getting taxed and without burning our contribution room. With the Home Buyer Plan (HBP) and the school plan, you are allowed to withdraw a certain amount of money (20K per eligible person for the HBP) and you benefit from a certain period of time to put it back into your RRSP account without paying taxes.


The only thing that you still have to consider in this situation is that you will still hurt your retirement plan. Sometimes it worth it, sometimes you can find other solutions for your money problems. I personally withdraw money from my RRSP without the HBP plan (it was for my second property) but it allowed me much more flexibility for my mortgage. When we talk about finance, it is not always black and white.


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Canadian Business just had an article on increasing numbers in the U.S. doing just this. It’s based on U.S. retirement accounts so a little different then here in Canada, but it really presents a warning to ensure our finances are in order to prevent this pitfall.


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