Dale Jackson

Personal Finance Columnist, Payback Time

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With holiday debt pouring in this time of year, Canadians might be eyeing their registered retirement savings plans (RRSP). In some cases it makes sense to withdraw before retirement, but often the cost is too high.

The most obvious drawback is the cost of not allowing your RRSP savings to grow tax free. Every dollar that stays in your RRSP is a dollar that can grow in an investment over a period of decades. As an added bonus, it can be withdrawn in a lower tax bracket in retirement.

But it’s the immediate impact of an early RRSP withdrawal that carries the biggest sting. Any funds drawn before the plan holder turns 65 is subject to a withholding tax. That means as much as 30 per cent of the amount withdrawn can be held at the source. The bigger the withdrawal amount, the bigger the withholding tax. 

 The withholding tax is held by the government until that year’s tax season rolls around. At that time, your RRSP withdrawal will be taxed at your personal rate. If you’re dipping into your RRSP early because your income has been cut or eliminated, you will probably receive some of the withholding tax back since you are in a lower income tax bracket. If you withdraw from your RRSP early and are still in your regular tax bracket, you could owe more – and that amount could be in an even higher tax bracket.

Also, once you've taken money out of an RRSP through an early withdrawal, you lose that contribution space forever.

It could make sense to dip into your RRSP early in two other cases: if you want to buy a first home or go back to school.

The Home Buyer's Plan (HBP) allows the plan holder to borrow up to $25,000 from their RRSP for a down payment on a first house. There is no withholding tax but there is a 15-year period to return the money to the RRSP. Once 15 years have elapsed, however, the opportunity to replace the borrowed money is permanently lost.

The Lifelong Learning Plan (LLP) allows the plan holder to withdraw up to $20,000 from their RRSP to go to an accredited school. Repayment does not need to begin until five years after the first withdrawal. Once your repayments begin, you will have 10 years to pay the money back to your RRSP before the opportunity to replace these funds is lost entirely.