RRSP question

[ak47num1]

I am just wondering what's the cost of early withdrawal from RRSP.

Consider the following scenario:

A taxpayer can lower her tax bracket by contributing $x to RRSP this year. Next year, she plans on withdrawing from the $x the max amount before bumping herself up to the next bracket.

So this year, she would gain from dropping herself to a lower tax bracket + gaining interest on the tax rate * contribution. Since she only withdraws up to her next tax bracket, she won't be paying higher tax next year. What's the penalty for withdrawing early then?

If I am really wrong, please advise. Thanks.

[xlfe]

fees wise there isn't a penalty. unless your bank or financial institution specifically charges one.

[asdfvcx]

First of all, you don't seem to understand how tax brackets work. Take a look at the example here: http://en.wikipedia.org/wiki/Tax_bracket

Second of all, you would lose contribution room this way, which could be a big deal to some people. And third, there are withholding taxes to consider.

So, this idea could work for some people in some situations, but this doesn't sound like one of them. And if you have no idea what I'm talking about, the simple answer is don't do it. :)

[Thalo]

The ultimate cost is that the contribution room is lost forever.

[ak47num1]

I appreciate all your responses. I would like to understand more.

To me, the case is for this person who does not have enough cash to contribute to RRSP and let the money stay there. He would need to withdraw what he contributes this year in the following year. Normally, he won't have enough to make a contribution, so the contribution room is not really a great cost. Apart from contribution room, does this move result in more money in her pocket in the end?

I am very interested in this and will plug the hard numbers into tax software once I buy mine for this year. Looking forward to hearing more input if possible :)

Thanks.

[dutchca]

You are missing the point that an RRSP is for retirement and tax deferral. You achieve neither by contribution and then withdrawing on a regular basis.

There are different withholding rates depending on how much you withdraw. None of the rates are usually high enough to offset the taxes owing on the withdrawal. I do remember thought that it is best to withdraw in increments of $5000. I think the rate on that is only 10%.

There is no way to play the tax brackets to make withdrawing from your RRSP beneficial.

Sounds like you are looking for an excuse to convince yourself to withdraw some money. I wouldn't, but if the cash is needed, there may be no other option.

[jojochiu]

$5000 or less is 10%
$5001 to $10,000 is 15%
$10,001 to $15,000 is 25%
$15,000 and over would be 30%

[Pavel]

The above is simply from your financial institution based on CRA rules. Once you file your taxes, you're further dinged.

[ak47num1]

In the end, you are only paying the withdrawal * marginal tax rate = the w/h tax + what you pay when you file your return.

No? The w/h tax isn't an extra tax.

[Pavel]

Maybe I'm getting confused. When you take out money from your RRSP, say $3K. The bank withholds 10% of that amount. Then, (please correct me if I'm wrong) the bank issues you a T4RSP slip at the end of the year that you include in your tax return as income.

[ghostryder]

Maybe I'm getting confused. When you take out money from your RRSP, say $3K. The bank withholds 10% of that amount. Then, (please correct me if I'm wrong) the bank issues you a T4RSP slip at the end of the year that you include in your tax return as income.

Yes, you include that income and will pay tax on it accordingly. If the withholding tax doesn't cover the tax you owe you will have to pay the balance.

To illustrate here are two examples:

Lets say you have no income whatsoever. none. You withdraw $3K from your RRSP, there is 10% withholding ($300). When you file your next return you have $3K in income, well below the basic personal exemption so you have no tax payable. You will get that $300 back (refund).

Lets say you have $25k in regular income, you withdraw that $3K from your RRSP. Lets assume that your employer deducted the exact amount of tax you will owe on the $25K, you have an additional $3K to add to you annual income. Lets say you are in a tax bracket of ~25%. Your tax owing on the $3K is $750 ($3000 x 25% = $750). Less the 10% already withheld means you owe $450 in tax ($750-300= 450).

Hopefully that is as clear as mud :)

[xlfe]

To me, the case is for this person who does not have enough cash to contribute to RRSP and let the money stay there. He would need to withdraw what he contributes this year in the following year. Normally, he won't have enough to make a contribution, so the contribution room is not really a great cost. Apart from contribution room, does this move result in more money in her pocket in the end?


he/she should definitely consider contributing to a TFSA.

[Pavel]

Yes, you include that income and will pay tax on it accordingly. If the withholding tax doesn't cover the tax you owe you will have to pay the balance.)

I never had to withdraw, so that's good to know. I was always under the impression that you have to add the T4RSP as income and then pay tax on top of the withholding tax that your financial institution takes. In the real world, most people will always have income and exceed their basic exemptions so they would have to pay additional tax on top of the amount withheld, as shown in your 25K example.

I assume the same would be true if you make multiple withdrawls, say 3K every few months, CRA will still nail you on the excess owing (assuming you have income).

[Jin-n-Juice]

I never had to withdraw, so that's good to know. I was always under the impression that you have to add the T4RSP as income and then pay tax on top of the withholding tax that your financial institution takes. In the real world, most people will always have income and exceed their basic exemptions so they would have to pay additional tax on top of the amount withheld, as shown in your 25K example.

I assume the same would be true if you make multiple withdrawls, say 3K every few months, CRA will still nail you on the excess owing (assuming you have income).

When you withdraw, they withhold taxes and remit them to the CRA. The amount of withholding tax they take depends on the amount of withdrawal. For withdrawals <= $5000, it's 10% I believe. Withdrawals of $5001-$15000 is a 20% withholding tax, and anything about $15000 is a 30% withholding tax. You get a T4RSP, and you will add the withdrawals onto your income and you will pay extra tax or get some/all of it back depending on your net income for the year.

You can make multiple withdrawals so that they don't withhold as much taxes, but you better be sure you can pay your taxes owing at tax time.

[asaad_187]

I agree, you should not be pulling out of your RRSP for personal use as it becomes part of your income. However, if you do not currently have a house under your name and you contribute to your RRSP you have the ability to pull out that money TAX FREE for the down payment on your house. This is known as the first time home buyers option and can only be done once if you do not currently have a house under your name. The minimum time to hold RRSP before the option is available to you is 9 months, after this you may pull out for a first down payment on a house or property. Hope this helps:cheesygri

[Thalo]

I agree, you should not be pulling out of your RRSP for personal use as it becomes part of your income. However, if you do not currently have a house under your name and you contribute to your RRSP you have the ability to pull out that money TAX FREE for the down payment on your house. This is known as the first time home buyers option and can only be done once if you do not currently have a house under your name. The minimum time to hold RRSP before the option is available to you is 9 months, after this you may pull out for a first down payment on a house or property. Hope this helps:cheesygri

It should be noted that this is not a tax-free withdrawal but rather a "borrowing" of your RRSP. You have to pay it back (and don't get the tax deduction when you pay it back).