Most articles on RRSP only cover contributing options but rarely does it cover what happens once you’re ready to withdraw it at retirement. In this post, I’m going to discuss everything you need to know about withdrawing your RRSP including the rules and taxes you should know about when making a withdrawal, what an RRIP conversion is, how your government benefits will be affected with your RRSP withdrawal and what happens to your RRSP if you pass away.
How RRSP works
We should cover the basics of RRSP so you can get the full picture of how it all comes together from the day you start contributing to when you retire. The Registered Retirement Savings Plan (RRSP) was first introduced in 1957 but it wasn’t popular until later. This is because the interest rate has been dropping year after year so guaranteed pension and term deposits are not performing as they once were. Also, the RRSP contribution room increased to 18% of the previous year’s income and will be indexed each year.
Canadians have a long life expectancy and combined with the low interest rate environment, the government and the employers would not be able to fully take care of every employee’s retirement which is why it’s up to you to save for your future. With RRSP, once you put that money into the account, your income on paper will be subtracted accordingly and therefore, you pay less tax. For most employees, this also means a bigger tax return by April. You pay less tax now and you’re saving for the future.
When you’re ready to retire, on average about 65 years old, you can begin to withdraw from your RRSP. You’re actually able to withdraw anytime as long as it is not in a locked-in account. Now here are the rules and taxes you should know about when it comes to withdrawing your RRSP.
The CRA always wants to make sure you don’t owe them money so they will pre charge tax on your RRSP withdrawal. This is called withholding tax. For Canadian residents, with the exception of Quebec, the withholding tax is outlined as follows:
Keep in mind that the withholding tax might not be enough to account for taxes you’ll owe in a higher tax bracket so it’s important to consult the right professionals before you make any big withdrawal.
For non-residents of Canada, the withholding tax is 25%, unless it’s reduced by a treaty. You can find more information about taxes on the CRA website.
RRSP becomes taxable income
Every dollar that you withdraw from RRSP will be subject to income tax 100%. For example, if you are making $50,000 this year and you withdraw $5000 from your RRSP, your income will now become $55,000 so that additional $5,000 will be paid at the highest tax rate
Not using your RRSP
Now if you have other forms of income such as TFSA, rental property, CPP and OAS so you don’t need to touch your RRSP, unfortunately your RRSP account will not be available forever. When you reach age 71, you’ll be required to transfer your RRSP to a Registered Retirement Income Fund (RRIF) account which is the RRIF conversion.
Registered Retirement Income Fund (RRIF)
The RRIF is the opposite of your RRSP because you will not be able to make any further contributions into the account and you are required to withdraw a minimum amount each year with the amount increasing as you age. However, you are able to have more than one RRIF account with no upper limit on withdrawals. Mandatory minimum withdrawals will only begin in the first year following the RRIF conversion. Due to COVID-19, the minimum required withdrawal amount on RRIFs has been reduced by 25% in 2020. This 25% reduction is applied to the entire 2020 withdrawal amount. For example, if your RRIF minimum amount before the reduction is $12,000 for the year. The new minimum for the 2020 year would be ($12,000×75%=) $9,000. The advantage to this is that you have the option not to withdraw as much. With RRIF withdrawals, you won’t be charged a withholding tax if you stay below the minimum annual amount. That also means that withholding taxes WILL be applied to amounts in excess of the minimum annual withdrawal requirement. Same as RRSP, any amount withdrawn from your RRIF will be considered as income, and will be taxed according to your tax bracket.
How Canadian government benefits affect your RRSP withdrawal
Besides your RRSP and RRIF income, you’ll also be able to start collecting government benefits as early as age 60. This includes the Canada Pension Plan (CPP), Old Age Security (OAS) and Guaranteed Income Supplement (GIS). Your eligibility for both the OAS and GIS will depend on your post-retirement income. Because of this, if you increase your income by withdrawing more from your RRSP or RRIF, you will lessen the amount of money that you will be eligible to collect from the OAS and GIS.
Your RRSP if you pass away
On death, either the RRSP and the RRIF will be terminated, and the entire account will be considered as your last year’s income and is fully taxable. For example, Henry has $500,000 in the RRSP account, once he passes away, the entire $500k will be considered his last year income, and therefore he is in the highest tax bracket and he has to pay $250,000 to the CRA. However, if Henry names his spouse or any financially dependent child as his beneficiary, then the whole $500,000 can roll over to them without paying any taxes.
Although it may sound counterintuitive, the worst thing you can have is to retire with too much money in your RRSP. Without proper retirement planning, there is a really high chance you’ll have to pay more taxes, receive less government benefits and have a big regret. As a financial consultant for over 10 years, here are my recommendations when it comes to planning for your retirement and your RRSP:
Trying to find the right balance of RRSP to maximize your retirement benefits will definitely require some planning! If you’d like a complimentary consult, please book an appointment with me and I can review your plan to let you know where you’re headed with your current strategy. Or, you can find me on YouTube where I cover topics on building wealth in Canada.