Cashing out early a bad idea, experts warn - Metro US

Cashing out early a bad idea, experts warn

If you’re strapped for cash and don’t know where to turn, withdrawing from your RRSPs should be the last resort.

“This would be similar to cashing in a pension plan early; you are really affecting your future ability to take care of yourself,” said Kevin MacLeod, certified financial planner and president of MoneyAdvisor.ca Financial Ltd.

Jeff Young, senior manager of financial planning support for RBC, says a lot of people don’t understand the power of the long-term compounded interest on an RRSP.

And there are a number of penalties that accompany cashing out those funds before retirement.
“Upon immediate withdrawal, there will be a withholding tax,” he said.

The institution housing your RRSP is required by the Canada Revenue Agency (CRA) to withhold a certain percentage of the money withdrawn: 10 per cent for any amount up to $5,000; 20 per cent for amounts between $5,001 and $15,000; and 30 per cent for any amount over $15,000.

Young said some financial advisers may suggest clients withdraw funds in $5,000 chunks to avoid the higher withholding tax, but this method is not the way to go.

“The CRA has come out explicitly and stated that they don’t support that approach,” he said.
“Some institutions may not even do it.”

After the withholding tax, the sum withdrawn is taxed at the individual’s taxation rate; it’s added to whatever other income accumulated that year.

There is no way to avoid the tax payable on an RRSP — all you can do is defer it, said MacLeod.

“When you file your income taxes the following year, the entire amount of your withdrawal is included in your income,” he said. “At that point, you either pay the additional tax you owe or collect a refund if what was withheld was too much.”

Finally, if you have no other option but to withdraw from your RRSPs, Young says you should think long and hard about it first.

“Think about, ‘How much do I need?’, and don’t take out any more than that,” he said.

It might make more sense to look at the root of the problem, he said. How did you end up in a situation where you need to consider your last resort?

“There could be a bigger problem there,” he said. “Don’t avoid it.”

More from our Sister Sites