The article “How to Know When to Start Drawing on Your RRSP” was originally published on The Financial Post on February 17, 2015.
There is plenty of information out there about RRSP contributions, ranging from why it’s a good idea to contribute, to how much to put into your RRSP and even which investments to purchase. It’s no surprise — the financial industry makes lots of money on your RRSPs. The topic garners both attention and advertising dollars. But what do you need to know about RRSP/RRIF withdrawals?
First off, you don’t need to start taking money out of your RRSP until the year you turn 72. By Dec. 31 of the year you turn 71, you need to either cash out your RRSP (not a great idea as it’s fully taxable), purchase an annuity from an insurance company (kind of like buying a 20-year GIC at today’s low interest rates) or transfer your RRSP to a registered retirement income fund (RRIF). RRIF withdrawals start at age 72 and can be based on either your age or your spouse’s age, following a formula as a percentage of your RRIF value for annual withdrawals.
That said, not everyone waits until age 72.
At the one end of the spectrum, for young people, RRSP withdrawals typically happen in one of three situations:
- A Home Buyers’ Plan (HBP) withdrawal to purchase a home.
- A Lifelong Learning Plan (LLP) withdrawal to pay for education.
- Financial difficulty.
RRSPs can be good tools to finance a home purchase or education for a young person in the right circumstances.
For older Canadians approaching or into retirement, RRSP withdrawals may be a matter of necessity. For many, RRSP accounts are their only source of retirement savings. For all the talk of TFSAs and non-registered investments, not everyone has the financial resources to amass multiple retirement accounts.
But for some lucky Canadians, they may have savings beyond their RRSPs. Having various pools of money to choose from requires a bit of planning as to which capital to draw upon first.
Those who retire early should at least contemplate the thought of early RRSP withdrawals. While the general consensus is to “defer, defer, defer,” sometimes it can be advantageous to consider early RRSP withdrawals, even if you have other sources of retirement savings to use, such as non-registered accounts or a TFSA. Paying a bit of tax now might otherwise save you a lot of tax later. Especially if your income is fairly low, you can try to preserve your future entitlement to government benefits like Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) by drawing down on your RRSPs early.
It may also be advantageous to consider converting a portion of your RRSP to a RRIF to generate $2,000 of potentially tax-free income. If you’re in the lowest tax bracket — below about $40,000 of taxable income, depending on your province of residence — the pension income credit wipes out the tax on up to $2,000 of eligible pension income, including RRIF withdrawals after the age of 65.
If your income is fairly high already due to large RRSP/RRIF withdrawals or pensions and you need additional money from your RRSP/RRIF for cash flow purposes, consider using home equity. It’s not a strategy for everyone, but sometimes borrowing at 3% is better than tapping your retirement savings and paying as much as 65% income tax (including OAS clawback) on RRSP/RRIF withdrawals.
Above all else, one of the best ways to determine if it’s time to start drawing on your RRSPs is to make a plan. Whether you do it on your own by projecting out your income and expenses or with a professional who can build a retirement plan, try to get a sense of future income, expenses, tax payable, government benefits and so on. It may help bring some perspective as to how best to fund your retirement and when to start taking money out of your RRSP.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.