The Hidden Costs of Withdrawing from Your RRSP

In a time of financial uncertainty, drawing on retirement savings as a standby source of cash can be tempting. However, most of us are not wired to think long-term, and short-term financial concerns can easily cloud our judgment. Before surrendering to the temptation of tapping into our RRSP, it's essential to consider the true costs involved. These costs include taxation, loss of compounded tax-free growth, and other financial consequences.

Key Takeaways:

• When withdrawing from your RRSP, you'll be taxed at your marginal rate, which can significantly reduce your net withdrawal amount.
• The loss of compounded tax-free growth can be substantial, as illustrated by the example of a 40-year-old who withdraws $30,000 from his RRSP, losing almost $325,000 in tax-free growth by the time he retires.
• Consider alternative sources of funds, such as paring back expenses, looking at non-sheltered assets, and liquidating other assets like a second property.
• Certain types of RRSPs, such as locked-in plans, may not allow for withdrawal, and some investments, like GICs, may not be redeemable until maturity.
• RRSP institutions have their own rules and time lines for withdrawals, and some insurance RRSPs may have significant surrender charges.
• Withdrawing from your RRSP in smaller segments can minimize withholding tax, but still only delays the full impact of tax, according to Revenue Canada.
• The best time to be fired is close to the end of the year, allowing for maximum RRSP contributions and tax benefits.

Statistics:

• Average return on investment: 10%
• Loss of compounded tax-free growth: $325,000 over 25 years
• Tax withholding rates:

+ Up to $5,000: 10%

+ $5,000-$15,000: 20%

+ Over $15,000: 30%

Sources:

• Sandra McLeod, director, personal advisory services, KPMG Peat Marwick Thorne
• Alisa Dunbar, principal, Sobeco Ernst & Young in Toronto