How do RRSP withdrawals work? Everything you need to know

For many Canadians, putting money into a Registered Retirement Savings Plan can be an easy decision. Doing so means you can potentially pay less in taxes today, since contributions are tax-deductible, while also building savings for the future and retirement. 

On the other hand, when you're taking money out of your RRSP (called an RSP at Tangerine), there are lot more considerations that go into making the right decision for you.

Ideally, you'd leave your RRSP alone until retirement, but there may be some scenarios, such as when you're going back to school or buying a house, where you might want to dip into the funds sooner. RRSP withdrawals come with tax consequences, and understanding the rules can help you make informed financial decisions. Let's break down the RRSP withdrawal rules so you stay on track towards your goals.

When can you withdraw from your RRSP?

You can technically withdraw money from your RRSP at any time if you don't have a locked-in plan. However, you might want to think twice before making a withdrawal before retirement. That's because a percentage of the withdrawn amount is withheld by your financial institution and paid to the government as a sort of prepayment on your income taxes for the year. This is what's known as withholding tax.

When you're ready to retire, you have a few different options for what to do with your RRSP, which we'll get into. By the end of the year in which you turn 71, you'll have to decide what to do, because your RRSP will have reached "maturity."

What is maturity?

Maturity is when the government requires you to close or convert your RRSP so that the money can finally be used to generate income for retirement (the whole purpose of the account!). At maturity, you have three options:

1. Cash out

You can withdraw the whole amount — or part of it — but beware: you’ll have to claim the entire amount as income when filing your taxes. Some or all of it will be paid as withholding tax upon withdrawal. The withheld amount gets applied to any income tax owed on your taxable income. If not enough was withheld, you could end up paying more during tax filing season.

2. Convert your RRSP to a RRIF

You can convert your RRSP to a Registered Retirement Income Fund (RRIF, called an RIF at Tangerine) and withdraw a steady stream of income from it to use in retirement. Here's the catch: you have to make annual minimum withdrawals from your RRIF, and these are set by the Canada Revenue Agency. While these minimum withdrawals count towards your taxable income each year, you only pay withholding tax on amounts above the minimum. 

READ MORE: What is a RIF?

When converting your RRSP to a RRIF, you don’t need to wait until you’re 71. You can convert it at any age you decide to retire.

3. Purchase an annuity

You can use your RRSP funds to purchase an annuity from a life insurance provider. Annuities provide a stream of income for a defined period or for life, based on the terms of the contract. There's no withholding tax on the amount used to buy the annuity, but you have to pay tax on the income payments you receive.

4. A combination of the above

Can you withdraw from your RRSP before retirement? 

While the short answer is yes, the tax implications can make it costly, depending on your withdrawal amount and taxable income. A better strategy may be to consider withdrawing from other options instead, such as your Tax-Free Savings Account (TFSA), where withdrawals aren't taxed.

However, there are two notable scenarios where government programs allow tax-deferred withdrawals from your RRSP before it matures. If you're buying your first home, you may be able to withdraw funds under the Home Buyers' Plan (HBP). You may also be able to withdraw funds under the Lifelong Learning Plan (LLP) to finance education for yourself or your spouse.

Withdrawals through the Home Buyers' Plan 

Under this program, eligible first-time homebuyers can withdraw money from their RRSP to use for the down payment on a home purchase. The withdrawal won't be subject to withholding tax or count as income. You'll have 15 years to repay the funds, starting the second year after you make the withdrawal. 

Each year, the CRA will send a statement that includes your balance owing, payments made and the minimum payment for the following year. Note that a portion of your annual RRSP contribution can be designated as an HBP payment on your tax return.

Withdrawals through the Lifelong Learning Plan 

If you or your spouse has ever considered going back to school, this might help with your decision. With the LLP, you can withdraw up to $10,000 annually to a total of $20,000 from your RRSP to finance full-time education or training. Want to spread the withdrawals over four years? 

You can do that, too, and they won't be taxable, as long as you pay the amount back to your RRSP over 10 years, generally starting the fifth year after your first withdrawal. (Note that it depends on individual circumstances; you may need to start the repayment earlier.) Similarly to the HBP, you can designate RRSP contributions on your income tax return to chip away at your balance owing.

What taxes apply when withdrawing from your RRSP?

You’ll have to pay withholding tax regardless of when you make your RRSP withdrawal. But you may have to pay more in income taxes if you withdraw from your RRSP before retirement, depending on your income at the time.

Paying withholding tax

Remember, this is the government's way of making sure you pay tax on your withdrawal. When you make an RRSP withdrawal, a withholding tax will automatically apply and be drawn from your account to pay the government. Different tax rates apply for RRSP withholding tax, depending on how much you withdraw and where you live.

Below are the tax rates on withdrawals you can expect. Quebec residents pay both a federal and provincial withholding tax. If you're a non-resident of Canada, your withholding tax rate is 25% (unless reduced by a tax treaty), regardless of how much you withdraw.

To paint a picture, let's pretend you need money for a new roof and are thinking of taking out $20,000 from your RRSP to pay for it. If you live in Ontario, you'll pay 30% withholding tax, which equals $6,000 (ouch!). 

Alternatively, consider comparing the cost of borrowing through a line of credit with the tax impact of an RRSP withdrawal.

On top of the RRSP withholding tax, it gets more complicated…

The timing of your withdrawal matters

Here's where the timing of RRSP withdrawals really comes into play. The benefit of waiting until retirement to withdraw from your RRSP is this: since you're no longer working, you are likely to be earning less income. This would put you in a lower tax bracket, which means you'd pay a lower tax rate. 

On the flip side, if you make a withdrawal while you're still working full-time, you'll have to add that amount as part of your annual income when you file your taxes, potentially pushing you into a higher tax bracket. So not only are you looking at paying withholding tax, but you could also be facing a higher income tax bill.

What are the consequences of early RRSP withdrawals?

Unless you're withdrawing money from your RRSP for your first home or education, early withdrawals can cost you money and potentially more when it comes to your future plans. Here are some of the consequences of early RRSP withdrawals:

Missing out on some of the benefits of compound returns

Ideally, funds in an RRSP have decades to grow without being taxed, so they can benefit from the power of compound interest or compound growth. (That's when the interest you earn, and/or the gains on your investments, are reinvested and also earn interest.) Withdrawing from your RRSP earlier means some of your money will miss out on the effect of compounding, which may mean less growth for your investments in the long run.

Losing that contribution room forever

Every year, there's a limit on how much you can contribute to your RRSP, based on your income and previously unused contribution room. When you withdraw funds from your RRSP, you don't get any additional contribution room, unlike with a TFSA. This impacts how much money you end up with in your RRSP when you retire.

There's no way to avoid these consequences once you make early withdrawals. Instead, create a solid financial plan that will help you avoid tapping into your RRSPs when you need money.

How do spousal RRSP withdrawals work?

A spousal RRSP can be a smart strategy for retirement planning if a couple has significantly different incomes. It allows the higher-earning individual to contribute to an RRSP (up to their personal annual contribution limit) for their spouse or common-law partner, who is considered the account owner (the annuitant). This way, you can split income sources more evenly in retirement and take advantage of tax benefits, now and in the future. 

This strategy may help reduce your overall household taxes because the contributor (the higher-earning spouse) may receive the tax deduction today, while the annuitant could withdraw money in retirement at a lower income tax rate.

Making withdrawals and the attribution rule

Spousal RRSPs are a rather complicated topic, so we won't be getting into the full details here. Unlike a personal RRSP, the annuitant—not the contributor—is entitled to make withdrawals from a spousal RRSP. But keep in mind there's a three-year attribution rule. If an annuitant withdraws RRSP contributions within three calendar years of when they were made, the CRA will attribute the amount to the contributing spouse, so they'll have to pay tax on the withdrawals at their higher income tax rate. Three years after the last contribution, the annuitant will be responsible for paying tax on any withdrawals.

To make this strategy as effective as possible for couples, it's best to hold off on making any early withdrawals from a spousal RRSP if you can help it.

Final thoughts

There's a lot to consider when it comes to RRSP withdrawals. By understanding your options at retirement, how early withdrawals work and some of the strategies that can help reduce the tax consequences, you'll be in a better position to make an informed decision. 

At the end of the day, it's important to feel confident about your future. Regularly reviewing your goals and making strategic financial decisions with your RRSP can help make sure you're setting yourself up for a comfortable retirement.