≡ Menu

How RRSP Withdrawals Work

The common trend in email questions these days regards paying down debt but considering an RRSP withdrawal to pay it down. As I’ve done an analysis on withdrawing from an RRSP to pay down credit card debt, I thought that it may be a good time to discuss the fine print of withdrawing from an RRSP.

In my opinion, for those still in working years, I’m not a big fan of withdrawing from an RRSP.  There are three major reasons for this, high taxation, the loss the contribution room, and the loss of years of tax free compounding.

RRSP Withdrawal Taxation

Withdrawals from an RRSP account are added to income for the year which are then taxed at your marginal tax rate.  This isn’t so bad if other income is low for the year, like in retirement, or a sabbatical.   But if you already have a high paying job, the withdrawal will simply add to your existing income and face income tax.

Withholding Tax

To help pay for this year end tax, the RRSP withdrawals face an initial withholding tax. Note that the withholding tax applies to EACH withdrawal and not the total annual withdrawal.

  • 10% for the first $5,000 (5% in Quebec)
  • 20% from $5,001 to $15,000 (10% in Quebec)
  • 30% for >$15,000 (15% in Quebec)

An Example:

40% marginal tax rate and $5,000 withdrawn would result in an initial withholding tax of $500, in addition to $5,000 added to reported income for the year. Providing that the extra income doesn’t result in a tax bracket jump, $5,000 x 40% – $500 = $1,500 owed at tax time.

Different Scenarios:

Withdrawals under the RRSP Home Buyers Plan (HBP), or the LifeLong Learning Plan (LLP) do not face income tax provided that they are paid back on schedule.  What about Spousal RRSP withdrawals?  For the details, check out this article on How Spousal RRSPs Work.

RRSP Contribution Room and Loss of Tax Free Compound Interest

As mentioned, once an investor withdraws from an RRSP, they lose that contribution room forever.  Unlike a TFSA where the contribution room is never lost.  While most Canadians never use all of their contribution room, it may be an issue for those who fully take advantage of the RRSP.  In addition, the earlier the investor withdraws from the RRSP, the more significant the damage as he/she is foregoing years of tax free compound interest.

Altogether, I believe that RRSP withdrawals should wait until close or during retirement when income is likely to be lower and the effects of losing contribution room and compound growth is reduced.  Have you seriously considered withdrawing from your RRSP?  If so, what was the reason?

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 15 comments… add one }
  • SavingMentor December 8, 2010, 11:13 am

    We did use an RRSP withdrawal strategy once. While my wife was still working but planning to go back to school, we made a large lump sum contribution to her RRSP to get the tax refund and then the following year when she had almost no income because she was in school we withdrew that same money and had to pay very little in taxes.

    We figured that this presented a unique opportunity that may not happen again in our lifetime, so we might as well take advantage of it.

  • Sustainable PF December 8, 2010, 12:42 pm

    The First Time Home Buyers Plan is a circumstance where you technically withdraw the funds, then pay them back over a period of up to 15 years. I used the HBP for my first house purchase and have been buying back those RRSPs over the last 5 years. Like SavingMentor I made a large contribution, then waited the mandatory 2 month waiting period, received the tax break and used the funds for my down payment.

  • DwellOn December 8, 2010, 2:44 pm

    We accidently withdrew from my wife’s RRSP this year. We contributed to the RRSP when it was intended for the TFSA. I asked the broker (questrade) to correct the accounts but they just withdrew the RRSP and it was hit with a withholding tax. Anyone know how to best deal with this come tax time? Did we lost that contribution room?

  • FT FrugalTrader December 8, 2010, 5:02 pm

    @DwellOn, the withholding tax will offset any tax owed from the withdrawal. I believe that the withdrawal resulted in a loss of contribution room.

  • saveddijon December 8, 2010, 7:51 pm

    Is there a way to avoid the withholding tax?

    Scenario: You were laid off last December, and have not found a job since. So far, your income for this year is zero. December rolls around. Idea: Withdraw $20K from your RRSP. After your personal exemption and your spouse’s exemption, you pay no tax. So money contributed at a high marginal tax rate can get taken out at zero tax rate just when you need it most.

    But according to the article, I have to give the government a $6K loan (30% withholding on $20K) just as I’ve been kicked in the gut. I’ll get it back next April, but that’s April. Is there a way out of this if you can prove you have no other income?

    (I’m not in this situation right now, but it’s one I’ve thought of.)

  • DanP December 9, 2010, 1:53 am

    saveddijon, no there isnt. The withholding tax is automatic, not much you can do about that.

  • Susan December 9, 2010, 2:37 am

    To reduce the withholding tax amount take it out in $4999 increments. There are a lot of tax planning opportunities when someone gets a package bit a lot of people panic and take payouts in cash rather than rolling them into RRSPs.

    Something I learned this summer is that if you name a beneficiary to the RRSP there is no withholding done when paid out AND IT IS THE ESTATES RESPONSIBILITY TO PAY THE TAX ON THE FINAL RETURN. we saw the short end of this for a client whose father died but je had named his mother as the beneficiary. There is no love lost between granddaughter and grandmother so elder got $100+ K tax free and junior has to cover the approx $30K in tax from balance of the estate. Thanks grandma!

  • Kate December 9, 2010, 2:45 am

    Withdrawals under the RRSP Home Buyers Plan (HBP), or the LifeLong Learning Plan (LLP) do not face income tax provided that they are paid back on schedule.

    Let’s say I withdraw HBP and then have a schedule to pay it back. What if I do not pay – how will I be taxed? The yearly scheduled amount would be treated as additional income every year? What about the withdrawal tax in this case? Thanks,

  • Bob December 9, 2010, 3:46 am

    I am considering it as my marginal tax rate is very low at the moment (self employed, only dividends) and I am concerned about the minimum withdrawals once the RSP is converted to an RIF when I turn 71. I would rather invest the money on my own and have the flexibility to withdraw it when I want in the future rather than have the gov’t tell me I MUST withdraw an ever increasing amount each year.

    My goal is to have enough equity to live on 4-5% withdrawal rates, rather than the 7.38% to 20% via an RIF.

  • Dr. Philosophy December 9, 2010, 4:03 am

    @ Dwellon

    The reason that the broker did this is transfers between RRSP and TFSA accounts are effectively prohibited since they are taxed at a rate of 100%. The government implemented this policy shortly after the invent of TFSAs because clever people had figured out how to make transfers between the accounts work tremendously in their favor.
    If you want to correct for your mistake simply take as much of the money that was withdrawn and recontribute it to your wife’s RRSP in the same contribution year the accidental withdrawal occurred. Of course you will in the end burn twice the contribution room you would have used if you hadn’t made a mistake, but mistakes must cost one something.
    The alternative is to just let it ride, absorb the extra income on your wife’s tax return, and let the withholding tax take care of (most, or all of) the extra tax liability. Whether or not this is attractive depends on her income for the tax year of the accidental withdrawal.

    @ saveddijon: In the scenario you describe, no it is not possible to avoid withholding tax. The only scenario besides the HBP or the LLP Kate mentioned where one can avoid withholding tax on a withdrawal of an amount within an RRSP account is if that amount is an overcontribution (i.e. a contribution in excess of one’s deduction limit), and even then it’s a PITA to get done.

  • Jungle December 9, 2010, 5:20 am

    I am seriously thinking about stopping future rrsp contributions for my wife, she is a lower income category and I’ve seen calculations work out infavor with the TFSA. Even for my self, I am about middle of income tax rate, so it’s border line, accouring to calculators on taxtips.

  • Alessandro December 10, 2010, 8:35 pm

    I am 23 and just started my full-time job after university. I have been investing in RRSP’s since I was 18 but have slacked of the last year or two as I purchased a car. Would I be better off investing in TFSA or continue contributing to my RRSP?

  • Vickie June 3, 2011, 11:58 pm

    I was going back to school full time for one year after being home with no income for several years. My husband makes a good living. We had a lot of line of credit debt and we bought a car for me to drive back and forth to school, plus we had to pay for my tuition and books. We needed some relief, so we cashed out over $50k in RRSPs. Now I learn that we owe a huge amount in taxes and that we could have used a LLP, to get at the max. $20k tax free, as long as we repaid it. I am desperate to fix this…can I?

  • Kenny December 9, 2013, 1:04 am

    Hi, I have a question regarding withdraw RRSP. My income was in 2012 $56000 and now I want to withdraw my RRSP $21000 in the December 2013 from bank to pay my debits. How much I will have to return money to CRA. AND In the February of 2013 I want to take RRSP $10,000 then how I will get the tax return and how much I will get in child benefit/month. Any advise. Thanks. Kenny_gua

  • sunny April 7, 2014, 12:12 am

    Hello FrugalTrader,
    Withdrawal from RRSP is like caught up between a rock and hard brick, especially from taxation point of view. It will hurt even more if there is step-growth of marginal tax rate due to increased income from RRSP withdrawal.
    My question: We are doing these very simple mathematical calculations for practical taxation which are too too old when they were first implemented.
    It is more than a century year old & they have not evolved a bit. My strong idea is about throwing these age old calculations where tax rate increase in a step-growth style and in stead, place (enforce) continuously variable tax rate. It means there is no step growth, but rate increases continuously. These calculations will be little tedious. With fairly simple tax calculation, there are many many tax consultants available today. Calculating the tax liability with continuous variable tax rate is easy to calculate by differential calculus.
    In that case there wont be undue hit or undue saving from RSP withdrawal.
    thanks.

Leave a Comment