RRSPs are not short term savings accounts.

This week, I received a phone call from a client. He asked how much he could take out of his RRSP. I explained the withholding tax on ad hoc withdrawals and the negative effect it will have on his overall Financial Plan. His response was “If I can’t get financing from the bank I am going to take money out of my RRSP to buy a quad for hunting season.” My first thought was if you can’t get financing for a quad, you can’t afford the quad. So, I thought today I would write about RRSPs and why you shouldn’t be using them as a short term savings vehicle.

How much can you contribute to your RRSPs?

RRSPs were introduced to Canadians in the late 50s to help them save for their retirements. With RRSPs you get immediate tax deduction, tax sheltering on the growth and a tax deferral until you start to withdraw money in retirement.

A person can put up to 18% of their earned income into a RRSP every year to a maximum of $23,820 (2013). The contribution limit will be indexed for 2014 and beyond. For example, a person that makes 60,000 per year can contribute 10,800 to their RRSP. Someone making 132,333 or more can contribute 23,820.

Related article:  How much can you contribute to a RRSP?

Financial ProblemsRRSP are for retirement.

RRSPs are one of the few vehicles that allow Canadians to save in a favourable way for retirement. Most Canadian’s income in retirement will come from RRSPs, TFSAs, and Pension Plans. Those with higher incomes or strong savers may have more diverse portfolios but my 20 years in this profession says that the average Canadian will have RRSPs and not much else. RRSP savings statistics suggest that most Canadians won’t even have an RRSP but that is for another discussion.

With that in mind, when a person saves for retirement they need to have a 30 or 40 year time horizon on that investment. Sadly, it seems that “long term investing” is now about a 5 year time horizon. Saving for retirement is hard. It requires sacrifice, long term vision and discipline. Short term gratification may be the ‘Achilles Heel’ for anyone’s RRSP portfolio.

Withdrawals from your RRSP.

Let’s be honest, stuff happens in life that we are unprepared for and sometimes there is no other way than taking money from your RRSP to meet that challenge. I am not talking about those situations. I am talking about the person who uses their RRSPs to go on holidays, buy a quad or pay off a debt. When a withdrawal is done withholding tax is taken off the sum of money withdrawn. 10% on the first 5000, 20% on 5001 to 15,000 and 30% on 15,001 and above.  You can see that to get 5000 net you will take a 20% hit. Depending on what the redeemer is using the money for they are probably buying an asset that will decrease in value and have no positive effect on their future income in retirement.

Related article:  Understanding withholding tax

We are in a society of instant gratification, “I want it now, and I don’t want to wait.”  Money is cheap with low interest rates. Spend, Spend, And Spend. Retirement is a long way out and I will have time to catch up. Time passes by quickly and any ad hoc withdrawal from a RRSP to meet a gratification, a want not a need, will have a detrimental effect on a person’s retirement plan. Before you know it, you will be 60-65 and will not have enough money to retire and more than likely not have whatever it was that you purchased with that withdrawal many years before.

Related article:  Principles of Saving Money

Saving money is hard. It requires discipline and vision and yes a saver may have to forgo some short term spontaneous purchases. Save for your fun in a non registered savings account or a product like a TFSA. Your future income in your senior years should be left in your RRSPs. You can do both, it is a choice.

Written by Scott Wallace

Scott Wallace has been in the Insurance and Investment industry for the past 19 years. His role is to take what is important to his clients and help them make those dreams a reality. Scott is a CFP, CLU and a Qualifying and Lifetime Member of the Million Dollar Round Table.

4 Responses to RRSPs are not short term savings accounts.

  1. This is a story about some friends of mine. Each year for the last 20 some odd years, he would contribute to a spousal RSP, then 3 years later she would withdraw the whole thing to be spent on a cottage, an RV, a boat, etc. Now, in their 60s, he had to go back to work because they can’t live on his very good work pension, and they have no RSP/RIF to fall back on. Just looking at the big picture from this perspective….instant gratification has its price.

  2. Permit me to express a contrary opinion.

    RSP accounts are best for short term tax planning. When used long term they suffer from several problems. Long term investments are ideally those which grow in value. Growth outside of an RSP is treated as a capital gain and half taxed. In an RSP, upon withdrawl it is taxed like income. Similarly, favourable tax treatment for dividends are lost when earned inside an RSP. The key tax advantage to an RSP happens if you put money in when in a high tax bracket and withdraw it in a low tax bracket. So in high income years, put money in. Then when you have a low income year, take it out. Use it for interest bearing investments, not those that earn dividends or are intended to be a source of capital gains. Might take a sabbatical sometime, RSPs are for you. Long term retirement savings, not so much. You might not live to see the tax paid, but it will be paid.

    The TFSA, although limited, is the place to put long term investments. It doesn’t have the temptation of a tax write off when you put money into it, but tax free is very cool. Everyone should put all they can into these plans. Unfortunately, there are modest limits on what can be put in, but these are accumulating and if you believe Harper (a bit of a stretch) the limits will go up.

    So IMHO, use RSPs for short term tax planning and your TFSA for long term income and capital gains.

  3. What if we withdraw from RRSP for short term and put the money back within the same year? Other that the growth the funds will lose during the period, are there any other consequences? Will the withdrawal be taxed?
    Thanks
    Jobby

  4. Hey Jobby! Unlike TFSA’s, RRSP room doesn’t reset after a withdrawal – it’s just gone. TFSA’s also don’t effect your OAS supplement unlike RRSP’s which do.

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