“Learn from the mistakes of others; you can’t live long enough to make them all yourself.” – Eleanor Roosevelt
Over the past couple of months, I’ve noticed a definite increase in the number of calls that I’m getting from people who want to know if they can withdraw money from RRSPs. The reasons for wanting to withdraw vary from person to person but essentially they boil down to the same thing: something unexpected happened, they need money and the only savings they have are in their RRSP. Having been in that same position in the past, I understand all too well the feeling of being underwater financially and grasping at whatever options I had to save me from drowning. However, I also understand all too well the consequences of those choices and how long it can take to ‘catch up’ with your retirement savings plan once you get back on your feet.
Related article: Everything you need to know about RRSPs
Here are three things I learned from my own experience that, hopefully, might help you avoid making the same mistakes:
Lack of Savings = Increased Vulnerability
While we know that saving makes sense, not enough of us make it a priority. With easy access to credit, many people feel less pressure to save because there’s always a line of credit or a credit card available in case of an emergency. The problem with this is that, if that emergency happens to be accompanied by a drop in income, your access to new credit will disappear and the debt you already have will become increasingly difficult to manage. Eventually, when all your available credit is maxed out, you’ll find yourself at an entirely new level of financial trouble; one that’s incredibly difficult to escape from without options such as bankruptcy, consumer proposal or another debt reduction program.
Related article: Are your protected from financial disaster?
Life is unpredictable. None of us know what the future has in store but having savings outside of your RRSP gives you a “buffer” against unexpected expenses or a sudden drop in income due to illness or job loss. The less you have in savings and the more debt you carry, the more vulnerable you are. If the only savings you have are inside your RRSP then it’s in your best interests to find a way to save more.
RRSP Withdrawal = Taxes
Money that is held inside a RRSP account is considered tax-deferred. That means that you don’t pay any taxes on it until you withdraw it from your RRSP account. One of the major advantages of RRSPs is that contributing to a RRSP account reduces your taxable income and puts more money in your pocket. If we want to take full advantage of RRSPs then we should be putting money in while we’re working and taking it out in retirement when our income is lower and we’re paying less tax. If you take money out while you’re working, the amount you withdraw is added to your income for the year and you’re taxed at whatever your marginal tax rate is.
Related article: Understanding Marginal Tax
For example: Jeff earns $90,000/year and decides to withdraw $20,000 from his RRSP. This makes his total income for the year $110,000 which, in Alberta, puts him in a 36% tax bracket and so he will have to pay $7,200 (36%) in taxes on that withdrawal.
Some of the taxes that Jeff owes will be withheld by his financial institution when he makes the withdrawal. The amount that’s withheld is determined by the withdrawal amount: $5,000 or less = 10%; $5,000-$15,000 = 20%; more than $15,000 = 30%. However, his financial institution has no way of knowing what Jeff’s income will be for the year and so, given that he’s in a 36% tax bracket, there’s a good chance that Jeff will owe more money in taxes when he files his return. That can be a nasty shock at tax time.
Related article: Understanding withholding tax
Catching Up on Retirement Savings = Not Easy
Five years ago, I pulled $10,000 from my RRSP account. I’d done an ok job of paying down debt but a poor job of building up an emergency fund so, when life handed me a house purchase, a marriage breakdown and a job loss, all within the space of 3 months, it didn’t take long for me to sink further into debt than I’d ever been before. The withdrawal cost me about $2,000 in taxes and the remaining $8,000 kept the debt demons away for a while, but it took a long time for me to get back on my feet and into a position where I could start saving again. Over the past five years, that $10,000 would have grown to about $13,500 but, if I’d continued to save $200 a month, it would have grown to about $27,300.
Related article: The hidden cost of debt
When you pull money from your RRSPs, it’s not just about the amount you withdraw but what that money could have grown to over time. When I pulled $10,000 from my account, I took about $59,000 out of the hands of my 65 year old self. If I factor in the impact of lost savings from the years that I didn’t contribute to RRSPs while I was getting out of debt then that number is closer to $90,000. Five years later, replacing that amount will take far more than the original $10,000 because my time frame is shorter. Assuming a 5% annual return, I’d need to save an additional $100/month (on top of my regular retirement savings) for the next 25 years to replace the $59,000, that’s a total investment of $30,000. If I wanted to replace the full $90,000 then that’s an additional $155/month (or $46,500). Looking at those numbers, it’s easy to see why, when people pull money from their RRSP accounts, it has a significant impact on their retirement account balance at 65.
A recent report, published by the Broadbent Institute, found that only 15-20% of middle-income Canadians have saved anywhere near enough for retirement. Whether this is a result of poor savings habits or repeatedly dipping into RRSPs is unknown, but I’m willing to bet that both were significant factors. With savings rates in Canada far lower than they should be and with debt rates being far higher, it’s important that we do whatever we can to keep as much money in our pockets as possible so it can work for us rather than our creditors or favourite retailers. Steering clear of raiding our RRSPs is one common-sense commitment we can all make to help achieve our retirement goals.
What do you think?