After establishing your Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) in Canada and seeing your savings accumulate, you will eventually want to learn how to properly withdraw your funds as income in retirement. In this blog, we’ll go over some important considerations when deciding whether you should withdraw from your TFSA or RRSP. Manage your tax bracket.
Withdrawing From Your Tax-Free Savings Account in Canada
One thing to note about TFSA withdrawals is that you have a set contribution room limit. The amount of money you withdraw can be added back to your account in the next calender year. This is not mandatory. It’s completely up to you, but the flexibility of knowing that withdrawals can be re-contributed makes it better to withdraw from a TFSA than an RRSP account. Once you withdraw the TFSA funds, you are free to use them as you choose. Most commonly, retirees will use the TFSA funds for a down payment for a home, educational purposes, an expensive item like a car or a vacation, or as an emergency fund as needed. There is no tax on withdrawals.
As we said above, you can re-contribute to the account, but you can only do that starting the following calender year. If you re-contribute in the same year as you took the money out and you don’t have contribution room left, there’s a 1% tax penalty per month on the extra TFSA funds in the account for each month that those excess contributions are in there.
The great thing about the Tax-free Savings Account is that you can use your money any way you want, without restrictions. Ideally, you want to use it for retirement, but you can also use it as an investment or for important purchases. Never any tax on withdrawals because you don’t get to write off contributions. Thanks Mr. Flaherty [deceased].
Withdrawing From Your Registered Retirement Savings Plan in Canada
When you want to do a withdrawal from your RRSP, you need to keep in mind that once you withdraw, the contribution room is lost. You will also be required to pay income tax on your withdrawal. Withdrawing early is not ideal, nor recommended because you lose the opportunity to tax-defer your retirement savings. Plus, unlike a TFSA, if you withdraw money from your RRSP that money is taxable income in the year of withdrawal. This tax amount depends on how much you take out. There will be withholding tax of 10%-30% of the amount withdrawn. Withdrawing $5,000 has a withholding tax rate of 10%, withdrawing between $5,001 and $15,000 has a withholding tax rate of 20%, and withdrawing more than $15,000 has a withholding tax rate as high as 30%. This is prepaid tax. It’s treated the same as tax withheld by your employer on salary.
An RRSP is designed for retirement with the purpose being to leave your money in the account for a long period of time until you’re ready to retire. That way, your money grows tax sheltered. However, there are exceptions:
1) Lifelong Learning Plan (LLP)
If you have a Lifelong Learning Plan, you will receive an RRSP loan without interest that helps finance education or full-time training for either you or your partner. The LLP allows you to withdraw a total of $20,000 from your RRSP in increment payments up to $10,000 per calender year. If you withdraw over the limit, the additional amount will be a part of your income that year. The thing to consider here is that you have up to ten years to re-contribute what you withdraw, and you’re generally expected to re-contribute only 10% a year, although you can re-contribute the full amount sooner if you want. By so doing, there is no income tax.
2) Home Buyers’ Plan (HBP)
Next up is the Home Buyer’s Plan. In this case, you can withdraw up to $35,000 from your RRSP tax free. That money has to be used as a payment towards purchasing a qualifying home. However, this is only valid for a first-time homebuyer. Just like the LLP, you have to re-contribute the amount you withdrew back into the RRSP account. You have 15 years to do so, either in small instalments or all at once.
Withdrawing from a TFSA or your RRSP can be ideal if you want to purchase a home, invest in your own education, or make a large purchase. However, there are restrictions you need to consider before you start withdrawing, and you need to be aware of those limits including withdrawal limits. While a TFSA is more flexible, the RRSP is meant to be for retirement and should be treated as such. Your age will be a big factor whether you want to withdraw from your RRSP.
What’s the best time to withdraw from your RRSP or RRIF? When you income is low, like in retirement. Why? That way you are in a lower tax bracket. RRSP work best: contribute when you are in a high tax bracket; withdraw when you’re in a low bracket. Plus, don’t forget that your money grows tax sheltered.
At Pension Solutions Canada, we specialize in assisting people in preparing for retirement. Allow us to evaluate and review your retirement income sources and assist you with retirement planning. Call us at 1-888-554-6661, or click here to book a virtual Zoom meeting.