The best way to think of your RRSP is as savings for the future, when you retire. There are ways that the government of Canada allows you to access your RRSP before then. We will give a brief summary of those possibilities.
This article's primary purpose is to discuss how to use the RRSP withdrawal tax calculator when figuring out your retirement income.
Read on to discover how the RRSP withdrawal calculator can help you make important life decisions.
Can I Withdraw My RRSP Before Retirement?
The short answer yes, you can withdraw a portion of your RRSP for either one or both of the following specific purposes before retirement.
- To buy a home under the Home Buyers Plan (HBP) if you qualify as a first-time buyer under Canadian law
- To fund your training or education through the Lifelong Learning Plan (LLP)
As you can see, the RRSP serves a dual purpose. It gives you the benefit of being able to unlock cash when you need it for worthwhile projects and provides you with a retirement pension.
Details of these two plans are discussed elsewhere on the Insurdinary blog.
Accessing either of these plans is considered a way of borrowing money from your RRSP. As with any loan, you have to pay it back. Repayment options for each differ but are not unduly arduous.
Can I Withdraw My RRSP Before Maturity?
You can withdraw from your RRSP at any time provided that your funds are not already locked into the HPB or LLP, or both. Note that a withdrawal before maturity is subject to withholding tax. The amount of the withdrawal also has to be included as income when you file your taxes.
Once you understand the tax implications of an RRSP withdrawal before maturity, you will be better able to decide if — and when — this would be the best course of action.
Early RRSP withdrawal means, as mentioned above, that you will pay a withholding tax. The amount of withholding tax will vary depending on which province you're in and on the amount you withdraw.
It also means that you will pay income tax on the amount you withdraw from your RRSP. You are obliged to report this amount as income on your income tax return.
This is where the RRSP Withdrawal Tax Calculator is exceedingly useful. One basic consideration to note is that if your current income is higher than your projected retirement income, you’ll pay more taxes if you withdraw from your RRSP now.
An RRSP Withdrawal Calculator, like this one, has already figured out all possible variables, no matter what your age or level of RRSP contribution, or, indeed the other CRA plans you currently participate in.
What Are the Other Disadvantages of Early RRSP Withdrawal?
You lose out on the compound interest accruing to your RRSP. The interest on RRSP contributions compounds over time, i.e., you earn interest on the contribution amount plus the interest accrued to date. Even if you only withdraw a small amount from your RRSP now, it could have a considerable impact on your retirement savings later.
You lose your remaining contribution room if you withdraw funds from an RRSP. As you no doubt know, each year you earn income, you earn RRSP contribution room. This is set at 18% of your earned income up to the allowable maximum for the tax-year concerned.
If you contribute to your RRSP throughout the tax year, you are allowed to roll over whatever you don’t use of your contribution room into the next tax year, and this is added to the 18% (currently applicable rate) for the next tax year.
There is a maximum limit as to how much you are permitted to contribute to your RRSP, and this is set by the Canada Revenue Agency (CRA). The maximum RRSP contribution limit for 2020 is $27,230, and for 2021 it is $27,830. You are allowed to contribute less money to your fund, but you cannot contribute more than the maximum limit per year, or more than the remaining contribution room allows.
So you need to think about whether you really want to severely limit your ability to make up lost ground and leave yourself with very little money to retire on.
The RRSP Withdrawal Tax Calculator
Let's assume that you are about to reach retirement age (65 is usual, early retirement at 60 is optional). There are several choices you need to make about how you withdraw your retirement pension from your RRSP.
This online RRSP Withdrawal Tax Calculator allows you to adjust figures such as
- The balance in your RRSP or RRIF (see below) at the beginning of the year
- Whether you want a fixed annual withdrawal amount or the maximum withdrawal allowed each year
- At what age you want to convert your RRSP into an RRIF (it is mandatory at age 71)
- Whether you want to use the age of your younger spouse or common-law spouse to calculate minimum RRIF withdrawals instead, which you must decide before receiving any payments from the fund
- The estimated rate of return (currently 8%) and your desired withdrawal for each year beyond 65
- The percentage of adjustment for inflation to apply to your annual withdrawal if you elect a fixed withdrawal amount
As you will see from how the figures change as you specify each of the above, the older you get, the less money you will have left in your RRSP. When you open the above link, without changing any of the numbers, you will notice that you will only run out of money in your 91st year if you start with a balance of $400,000.
It is quite possible that you will live until 91, but if your family history and your current state of health indicate otherwise, you might like to derive the benefit of your pension before you die. See what the effect of withdrawing $2,000 or $3,000 more than the suggested $30,000 per year affects that bottom line.
If you are under the age of 71 and need income periodically (as opposed to monthly), you're better advised to leave your money in an RRSP and only make the occasional withdrawal. This is because, for many, there is life beyond the age of 71, when your RRSP matures.
Which Is Better – Fixed Withdrawal or Maximum Withdrawal?
Financial advisors will tell you that the deciding factor in which RRSP withdrawal option you choose — and when — all boils down to working out how to reduce your income tax payable as much as possible. This is one reason using the automatic RRSP withdrawal calculator is a good idea. The trick is to do these calculations periodically.
We recommend a periodic review of your RRSP withdrawal possibilities because your financial situation is subject to change. You might change jobs, for example, and earn significantly more or a lot less than you do now.
This will have a knock-on effect not only on your level of RRSP contributions but also on the amount of income tax you pay now and the income tax you will pay when you start receiving RRSP payments.
When using the RRSP withdrawal tax calculator, remember to keep an eye on the balance you will have when you convert from an RRSP to an RRIF.
One tax tip worth bearing in mind is that you can convert a portion of your RRSP to an RRIF at age 65. Yes, a partial conversion is possible, and you should ask about it when you first establish your RRSP. Partial conversion at age 65 will:
- Enable you to create a pension income that is eligible for the pension income tax credit
- Permit you to apply for the pension income tax credit when submitting your income tax return
- Allow you to opt for pension income splitting with your spouse
Notes on Pension Splitting
Note that if both you and your spouse are in the same tax bracket, pension splitting is unlikely to reduce your marginal tax rate. It might be useful, though, if it results in the creation of a pension tax credit for the transferee (the one to whom the split-pension amount is transferred) or increases the amount of the transferee's pension tax credit.
By the way, pension splitting does not mean that you actually split your pension with your spouse (although you can if you want to). It is merely a method of reducing one spouse's taxable income by allocating that income to the other spouse's tax return. Of course, both spouses have to agree to this beforehand and have to file Form T1032 with the CRA.
Mandatory RRSP Withdrawals at Maturity
Your RRSP reaches maturity on the 31st of December of the calendar year in which you have your 71st birthday. You will need to convert your RRSP into an RRIF by December 31st of the year of your 71st birthday or choose one of the other two options below.
Each option has a tax implication.
Option 1 - Lump-Sum Withdrawal
Option 1 is to make a lump-sum RRSP withdrawal. This will be subject to withholding tax, which is deducted immediately upon withdrawal and paid directly to the government. You must declare this amount as income when filing your taxes.
Option 2 - Conversion to an RRIF
You can choose to convert your RRSP to an RRIF (Registered Retirement Income Fund). An RRIF gives you a steady flow of retirement income. You need to withdraw a minimum amount each year.
Your minimum annual withdrawal is not subject to withholding tax at the time of the withdrawal but must be included in your taxable income each year. If you withdraw more than the minimum amount, that additional amount will be subject to withholding tax.
The schedule for RRIF withdrawals is slightly different from the RRSP withdrawal calculation. Your return might not exceed your RRIF withdrawal rate in which case you could eventually outlive your savings.
The reason we mention this, is that you need to look carefully at the amount you will have left in your RRSP when you turn 71 and whether this will be enough to live on if you survive for another 10 or 20 years.
Option 3 - Purchase an Annuity
Converting your RRSP to an annuity that offers a guaranteed income for life or for a specified period. An annuity is a type of life insurance where you deposit a lump sum with an insurer in exchange for the insurer guaranteeing you a regular monthly income for a fixed period of time.
Most annuities include a named beneficiary clause so that you can bequeath any remaining benefits in your annuity in your will to a person of your choosing.
Withholding tax is not applied on amounts that are used to purchase an annuity. When you start receiving payments, you may be liable to pay tax on the income.
Future Financial Security
It's a fact of life that we have to plan for retirement and act upon our decisions every step of the way. Fortunately, the CRA assists you, as citizens, with just that, so that you can enjoy life, even in your senior years.
If retirement is still a distant dream, you should still think about working towards financial security for you and your family early on by committing to other types of insurance products. Only once you have investigated their tax implications, that is.
Well-Calculated Decisions Are Best
Participating to the fullest extent in your RRSP is one way to get ahead in life. This is why the RRSP withdrawal tax calculator is an essential tool when planning your finances and thinking about retirement.
By using an RRSP withdrawal calculator you can save on the amounts you pay in taxes both before and after retirement. It will help you make sound investments for your future.
Visit Insurdinary today to discuss the many ways we can assist you in finding the best quotes for all of your insurance needs.
