Let’s face it, the Registered Retirement Savings Plan or RRSP tax qualified plan in Canada has its ups and downs in popularity. And it’s not because it’s good or bad. It just is. Every financial product has its own set of characteristics in terms of tax consequences, risk, volatility and control.
However, Canadians are seeking safe and secure retirement alternatives in a post covid-19 world. With the aftermath of markets shifting so drastically in the 2008 financial crisis and then again during the recent global pandemic, Canadians received yet another wake up call. People often wonder, can I take money out of my RRSP without paying tax?
The short answer is no. The anatomy of a registered retirement savings plan / RRSP confuses many Canadians. If you have an RRSP, it’s important to understand that when you created it, the taxes were there from the very beginning. Yes, you are postponing the payment of tax and more importantly, the calculation of tax, but the taxes are there from inception. What’s worse is that as the account compounds, you’re also compounding the tax. Correctly classifying anything is important. Think about the name Registered Retirement SAVINGS Plan. Savings can only be achieved inside of an instrument where there is no risk of loss. Yet more often, the account is actually an Investment tool versus a savings tool because the account owner’s money is invested in instruments like mutual funds. What’s scary is the account owner believes they are saving money. Investing is not saving. Why? Invested money is ALWAYS subject to risk and the very definition of risk is to subject someone or something to undue harm or “loss”. Money that is saved cannot be subject to the risk of loss. Not understanding the distinction can be devastating to you financially and cost you tens or even hundreds of thousands of dollars. Combine the misclassification with temperamental & risky stock markets, and you may very well be gamling with the retirement dreams of your family.
Withdrawing money from RRSP
There is no fool proof way to take money out of an RRSP without paying tax. Sorry… the tax trap and the pain it causes is real! That being said, if your objective is to reallocate the money inside your RRSP for some other purpose, there is hope. Equipped with the knowledge, you can start taking control back over your financial life. By getting clear on where you are today and where you want to go, you can strategize with an experienced advisor along with your accounting professional on how to strategically meltdown your RRSP accounts to start creating the financial future you want.
The premise of an RRSP is that you can get a tax break today at your current income tax bracket and “defer” the tax calculation to a later date. This hinges on several fundamental assumptions
Do you believe that the Government will require more or less money in the future? If you thought more, you’re probably right. And where do you think that money will come from? Taxable accounts and taxable income. Government is running record setting deficits. Someone has to pay the bill. That someone is You, Me, every other taxpayer and those who come after us. Based on this fact and the advances in modern medicine, people are living much longer. And so your need to save for your retirement inside of a tax free environment without market risk, government intervention, or a risky stock market is now more important than it has ever been.
The current RRSP withholding percentages (%) as at Nov 7, 2020 are (Not including Quebec):
Here is an example. You have an RRSP account with a value of $100,000. You decide to withdraw $30,000 from the account in one calendar year. Thirty percent (30) or none thousand ($9,000) of the withdrawal is forwarded to the Canada Revenue Agency and they wait for you to file your next income tax return in order to determine based on all of your taxable income, whether enough tax was withheld, or whether more income tax is due.
Who’s in a position of control? Who controls the percentage of withholding tax?
And so your RRSP account value goes down -$30,000 and you are left with $21,000 to decide where to put that money to work, preferably in a “never taxed” environment.
The reality is that tax must be paid on RRSP withdrawals at a future tax rate that is unknown.
“The moment you have awareness, you have control. The absence of awareness amplifies the fear of the unknown.” – Sam Qurashi
To complete the example, when you file your next year’s income tax return, you would add $30,000 to your total gross income for the year, and the $9,000 withholding tax is recognized in the determination of your final tax bill, or refund. If your total gross income was $100,000 it would now become $130,000 when you file your taxes. $9000 of that total tax bill will have been “prepaid” meaning you were never able to touch that money to use it for anything else.
If you knew that you were going to have a lower income in any given tax year, and you’re contemplating accessing your RRSP, it may make sense to consider a withdrawal in that year but it’s very important to always consult with a designated tax professional, i.e. a Chartered Accountant for tax advice specific to your circumstances.
There are a few other options available to Canadians to take money out of their RRSP. These are temporary options however and they come with strings attached. For example, The Home Buyers Plan (HBP) allows for up to $35,000 tax free withdrawal towards a home purchase. There are restrictions and limitations but the most important time is the requirement to put all of the money back into the RRSP plan within 15 years. You are required to pay it back in a maximum of fifteen (15) years or take the tax hit in the year you stop making repayments. Interestingly this repayment plan method is restrictive and does not give the RRSP owner much control over the repayment terms.
In contrast, there is a different tool named a participating dividend paying whole life contract (par policy). Because a par policy owner has a growing pool of financial value, that policy owner is in a position of total and absolute control. Meaning, the policy owner can use the daily growing cash value as collateral for either a policy loan from the Life Insurance Company, or a Loan from a commercial bank. When a loan is accessed, it is unstructured, meaning the policy owner controls the repayment schedule and their entire pool of financial value (cash value) continues growing and compounding uninterrupted. ABC = Always Be Compounding. The money can be used for anything that you would have otherwise paid cash for, leased or financed throughout the course of your lifetime. For example, homes, investments, personal or corporate expenses, business equipment, education, vehicles, and so much more.
Another RRSP withdrawal program exists for Education grants where you can use these funds to pay for education called the Lifetime Learning Program (LLP). A repayment model is required similar to the Home Buyer Plan. You can only take out $10,000 in a year and up to a maximum of $20,000 lifetime. There are many other qualifications of course. You have to prove a variety of things about the qualified education and meet other guidelines and criteria. Much like the Homebuyer Plan if a Canadian had equivalent value created inside of a tax efficient participant dividend paying whole life contract they could take a policy loan with no question asked or restrictions. These funds could be used to fund education up to the available equity in the policy cash values. Plus, they would then have full control and autonomy of the repayment of those education costs. These repayments could then in turn be used for a future purchase or retirement income in later years.
The RRSP platform has been available in Canada since 1957 when it was launched. Double taxation on any asset or investment should be a consent for anyone. It is unlikely that you would have double taxation on an RRSP. However, tax rates on income varies dramatically over time. As such, if you put $10,000 into an RRSP in your early working years when you were earning $40,000 in gross income at a marginal tax rate of 30% you would have reduced your taxable income to 30,000. The impact would have been lower taxes in that one year. By deferring the tax payable on a “known” rate of income tax, the $10,000 is not subject to a future unknown tax rate that will never be known until the day of withdrawal.
Withdrawal must happen. There is no choice in the matter. It is required to start the year you turn 71, but if you were to die early the entire RRSP could be considered income and drastically increase your tax rate and final tax bill. Not being able to plan for the amount of your future income and the taxation rates that a future federal government might initiate is a risky gamble for the person investing with an RRSP. Later in life, at the retirement stage, many Canadians including the baby boomers are experiencing a nerve racking wake up call. The tax rates have increased substantially and now the impact of a withdrawal may actually be costing much more than the initial tax savings received when the money first went into their account.
We have expert financial advisors and coaches that can help you with RRSP withdrawal rules and understand their impact in your life.