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More than a third of Canadians are withdrawing from their RRSPs before retirement

There are only two good reasons to withdraw from your RRSPs early.
There are only two good reasons to withdraw from your RRSPs early.

As their name implies, Registered Retirement Savings Plans are intended for retirement. But it turns out that thousands of Canadians have cashed in some of those funds well before reaching that stage in life.

Thirty-four per cent of us have withdrawn money from RRSPs in advance of retiring, according to a new BMO Financial Group study.

The top reason was to buy a home, with 25 per cent of Canadians withdrawing for that purpose. Twenty-one per cent withdrew to pay off debt; another 21 per cent withdrew to help cover living expenses. Fifteen per cent, meanwhile, withdrew funds to cover emergency costs like those for a car crash or house flood.

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According to the study, Canadians have, on average, withdrawn $15,908 from their RRSPs. One third have paid back the money, but 25 per cent expect they will never pay it back.

The highest rate of early withdrawal was in Atlantic Canada (40 per cent), while the lowest was in Alberta (32 per cent). People living in B.C. withdrew the most: an average of $24,100.

Withdrawing early to use RRSPs for short-term needs is a strategy that financial experts frown upon.

Early withdrawal comes with tax consequences. For starters, you pay a withholding tax. Your financial institution will hold back the tax on the amount you take out and pay it directly to the government on your behalf.

The withholding tax rate is between 10 per cent and 30 per cent, depending on how much you withdraw. In Quebec, the rate is between 5 and 15 per cent, and there provincial tax is also withheld.

Here’s an example of the financial hit (in all provinces but Quebec): If you withdraw $20,000 from your RRSP, you’ll be subject to a 30 per cent withholding tax, which comes to $6,000. That leaves you with just $14,000.

You also have to report the amount you withdraw on your tax return as income, and you may have to pay more tax on it.

There’s another downside:  “The amount that you withdraw from an RRSP is lost from your contribution room and you would have to rely on existing and new earned contribution room in the future,” says BMO Wealth Management’s Chris Buttigieg, senior manager of wealth planning strategy.

Of those who have made an RRSP withdrawal, 84 per cent said they only did so as a last resort, the study found.

Nearly 80 per cent said they were very concerned about the loss of retirement income, and 77 per cent were worried about not being able to save effectively for retirement.

When it’s okay to borrow from RRSPs

It may make sense to borrow from your RRSPs in two cases when it’s tax-free.

One is when buy your first home. You and your spouse each can borrow up to $25,000 from your RRSPs for a down payment on your first home under the government's Home Buyers' Plan (HBP). You don’t pay tax on the money provided you pay it back over the ensuing 15 years.

The other is to pay for education or training. You and your spouse can each borrow up to $20,000 from your RRSPs to pay for full-time or part-time education or training expenses under the government's Lifelong Learning Plan (LLP). The maximum you can take out in any year is $10,000. You won’t pay any tax as long as you pay the money back over a period of 10 years.

Rather than having to dip into your RRSPs, Buttigieg recommends having an emergency fund in a short-term savings vehicle like a tax-free savings account.

“The best time to withdraw from RRSPs is when you reach retirement, but as we’ve seen from this study, many Canadians can’t delay the withdrawal until its intended purpose and sometimes need to take out money prematurely when there is no other income available,” Buttigieg says. “If you’re considering making an early withdrawal from your RRSP, it’s a good idea to speak with a financial professional who can help determine the impact the withdrawal will have on your retirement savings.”