Common topics you read about RRSP only cover contributing options or whether you should invest in RRSP, but one question that is rarely top of mind when you’re putting in money into your RRSP is what happens when you are retired and ready to take it out?
If you’ve been here on my blog before you know I’ve covered everything from RRSP 101, 5 types of people who should get an RRSP, RRSP loans and more. Today I’m going to discuss how to withdraw RRSP when you retire. Everyone wants to be comfortable and secure when they retire so you start putting your money into an RRSP… then what?
In this post, I’ll cover:
- How to withdraw your RRSP
- Rules and taxes when you make an RRSP withdrawal
- What an RRIF conversion is
- How Canadian government benefits affect your RRSP withdrawal
- What happens to your RRSP when you pass away
How the Registered Retirement Savings Plan (RRSP) works
It’s important to cover the basics of RRSP so we get the full picture of how it all comes together from the day you start contributing to when you retire. The Registered Retirement Savings Plan, or RRSP for short, was first introduced in 1957 but it wasn’t that popular until the 90’s. Why? There are two reasons:
- Since the 90’s, the interest rate has been dropping tremendously meaning those guaranteed pension and term deposits are not performing
- The RRSP contribution room increased to 18% of the previous year’s income and will be indexed every year
With Canada’s long life expectancy and low interest rate environment, both the government and the employers would not be able to fully take care of the employee’s retirement life and as a result, it is up to the Canadian to save for their future. The idea behind the RRSP is that once you put money into the RRSP account, your income on paper will be subtracted accordingly and therefore, you pay less tax. For most employees, this also means a bigger tax return by April. You pay less tax now and you’re saving for the future – sounds like a plan!
Now fast forward to years later when you’re about to retire. The average expected age for retirement is usually 65. For many of you, this is where you might begin withdrawing from your RRSP. After all, you need retirement income. Well, you’re able to withdraw from your RRSP anytime you want as long as it isn’t in a locked-in account. However, there are a couple things you need to pay attention to when you are making an RRSP withdrawal:
- Every dollar that you withdraw from RRSP will be subject to income tax 100%. This means if you are making $50,000 this year and you withdraw $5000 from your RRSP, your income will now become $55,000 so that additional $5,000 will be paid at the highest tax rate.
- The CRA always wants to make sure you don’t owe them money so they will pre charge tax on your RRSP withdrawal, or called withholding tax. For Canadian residents, with the exception of Quebec, the withholding tax is outlined as follows:
- Withdrawing $5000 or less from RRSP is 10%
- $5001-$15,000 is 20%
- $15,000+ is 30%
Keep in mind that the withholding tax might not be enough to account for taxes you’ll owe in a higher tax bracket so it’s important to consult the right professionals before you make any big withdrawal.
For non-residents of Canada, the withholding tax is 25%, unless it’s reduced by a treaty. You can find more information about taxes on the CRA website.
What if I have other income such as TFSA, rental property, CPP and OAS – can I just not touch the RRSP money in my RRSP then?
Unfortunately, we have bad news here. Your RRSP account will not be available forever. When you reach age 71, you’ll be required to transfer your RRSP to a Registered Retirement Income Fund (RRIF) account which is the RRIF conversion.
What is a RRIF (Registered Retirement Income Fund)?
Think of this account as the opposite of your RRSP:
- You will not be able to make any further contributions to this account
- You are required to withdraw a minimum amount each year and the minimum amount will increase as you age
Unlike an RRSP, you are, however, able to have more than one RRIF account. While there is no upper limit on your withdrawals, mandatory minimum withdrawals will only begin in the first year following the RRIF conversion.
It’s worthy to note that, in 2020 due to COVID-19, the minimum required withdrawal amount on RRIFs has been reduced by 25%. This 25% reduction is applied to the entire 2020 withdrawal amount. For example, let’s say your RRIF minimum amount before the reduction is $12,000 for the year. The new minimum for the 2020 year would be ($12,000×75%=) $9,000.
What’s the advantage then? Mainly if you don’t want to withdraw that much money, you now have the option not to. You can find more information on the 2020 reduction on the CRA website.
The big idea for RRIF withdrawals is that you won’t be charged a withholding tax if you stay below the minimum annual amount. That also means that withholding taxes WILL be applied to amounts in excess of the minimum annual withdrawal requirement. Same as RRSP, any amount withdrawn from your RRIF will be considered as income, and will be taxed according to your tax bracket.
How Canadian government benefits affect your RRSP withdrawal
So how do government benefits play a part in all of this? Besides your RRSP and RRIF income, you’ll also be able to start collecting government benefits as early as age 60. This includes the CPP (Canada Pension Plan), the OAS (Old Age Security), and the GIS (Guaranteed Income Supplement). Your eligibility for both the OAS and GIS will depend on your post-retirement income. Because of this, if you increase your income by withdrawing more from your RRSP or RRIF, you will lessen the amount of money that you will be eligible to collect from the OAS and GIS.
What happens to my RRSP when I die?
On death, either the RRSP and the RRIF will be terminated, and the entire account will be considered as your last year’s income and is fully taxable. For example, Henry has $500,000 in the RRSP account, once he passes away, the entire $500k will be considered his last year income, and therefore he is in the highest tax bracket and he has to pay $250,000 to the CRA. However, if Henry names his spouse or any financially dependent child as his beneficiary, then the whole $500,000 can roll over to them without paying any taxes.
So as you can see, although it may sound counterintuitive, the worst thing you can have is to retire with too much money in your RRSP. If you have no exit strategy, aka no proper retirement planning, there is a really high chance you’ll have to pay more taxes, receive less government benefits and live in a big regret for the rest of life.
As a financial consultant for over 10 years, here are my recommendations when it comes to planning for your retirement and your RRSP:
If you are 20, 30, or 40 years old, I think RRSP is a great tool to have. It helps you to save more taxes, and create that long term saving habit. But if you are in your late 40s to early 50s, and you want to retire in the next 10-15 years, I would highly recommend checking your RRSP strategy to see if it makes sense to still continue putting money into your RRSP or if you should focus on other accounts like the TFSA.
Next is to understand what kind of retirement income you will have when you are retired. Are you solely dependent on the RRSP or do you have other income such as rental income, pension, etc? When you have multiple income streams, then you have a lot of flexibility to choose when is the best time to take out your RRSP.
Lastly, if you don’t have the time to think about or are overwhelmed by this information or just want some professional advice, I would highly recommend working with an advisor to sit down and discuss your retirement plan to find out if you have enough or are on track with your dream retirement. They’ll be able to advise whether you should start withdrawing RRSP now or wait until later.
Trying to find the right balance of RRSP to maximize your retirement benefits will definitely require some planning! If you’d like a complimentary consult, please book an appointment with me and I can review your plan to let you know where you’re headed with your current strategy. Or, you can find me on YouTube where I cover topics on building wealth in Canada.