Now that you’ve watched your savings grow, you’ll eventually want or need to spend it. There are many different ways to use your savings – here are some guidelines to help you decide whether you should make a withdrawal from your RRSP or TFSA before retirement.
Withdrawals from an RRSP
If you make a withdrawal from an RRSP, this contribution room is permanently lost, and you’ll pay income tax at the time of withdrawal. You may pay higher taxes at this point because your annual income may be more than when you’re retired.
Generally, early withdrawals from an RRSP are discouraged because it means you’re losing the opportunity to save for retirement on a tax-deferred basis. That’s because the main purpose of an RRSP is to save for retirement. There are a few exceptions though:
1) Home Buyers’ Plan (HBP)1
- First-time home buyers can use the HBP to withdraw up to $25,000 tax free from an RRSP to put towards the purchase of an eligible property.
- First-time means that in a four-year period, you didn’t live in a home that you or your current spouse or common-law partner owned.
- You may be considered a first-time home buyer again in the future once the four-year period has passed.
Any amount withdrawn under the HBP must be re-contributed to the RRSP. Generally, you have up to 15 years to re-contribute your HBP withdrawal, with payments starting the second year after you withdrew funds. You can repay the entire amount at any time.
2) Lifelong Learning Plan (LLP)1
- The LLP gives you an interest-free loan from your RRSPs to finance full-time training or education for you, your spouse or common-law partner.
- You can withdraw up to $10,000 per calendar year, to a total of $20,000.
- If you withdraw more than the annual or total LLP limit, the excess will be included in your income for the year you exceed the LLP limit.
You have up to 10 years to re-contribute any withdrawals. Generally, 10 per cent of the withdrawal is due each year until it has been repaid in full. You can repay full amount at any time.
Withdrawals from a TFSA
If you withdraw money from a TFSA, you can add this money back to your account in the future. There’s also no obligation to re-contribute TFSA withdrawals. For this reason, it’s generally favourable to make withdrawals from a TFSA instead of your RRSP.
You can use the funds from a TFSA in a similar way to the HBP or LLP for a home down payment or education. Other common uses for a TFSA include an emergency fund, vacation, or big-ticket item.
If you do want to re-contribute your withdrawal to your account you must wait until the next calendar year to do so. For example, if you make a withdrawal in February 2016, you have to wait until January 2017 to re-contribute the amount you withdrew. If you re-contribute too soon, you’ll have to pay a one per cent tax penalty on the excess TFSA amount per month, for each month you have excess contributions.
The TFSA can essentially be used for whatever you choose. But remember – using it for retirement is also an important option. When you use a TFSA for short-term investment purposes, you lose the potential for additional tax-advantaged growth. That could mean a big difference to your savings when you’re ready to retire.
1 HBP and LLP rules can be complex. I can provide you with more detailed information on these plans.