Ask the Expert: Should I withdraw from my retirement savings?

Life, inevitably, comes with twits and turns. Sometimes, those twists and turns involve financial struggle. Reader, Seth, is in the midst of one of these turns and is considering dipping into his Registered Retirement Savings Plan to help bridge the financial gap. Chartered Professional Accountant, Adeola, helps Seth understand the ins and outs of what that would mean for his financial future.

The question

I’ve always heard… leave your retirement savings alone! Don’t touch it!
I’m 29 years old and unfortunately just got let go. Timing being what it is, I recently got a car. Nothing fancy, but there’s still so much left to pay on it. I have no idea how long it’s going to take me to get a new job. I’m worried about keeping up with the car payments. Should I take out some money from my RRSP to pay off the car?
Any help is much appreciated,
Seth L. Victoria, BC

The answer

Financial emergencies happen often. For the average Canadian, a financial emergency could be a job loss, health issues, or a faulty home appliance. Without savings, a financial emergency can lead to worry and financial anxiety.

If you lose your job or have an emergency, what happens if you do not have buffer savings or an emergency fund? You can borrow funds from family and friends, use credit card debt, or withdraw from your savings, including your registered retirement savings plan (RRSP). Borrowing money from family and friends may come at no cost. Or, if the relationship sours, a great cost. On the other hand, if you use credit card debt, you will need to pay interest charges. If you are considering withdrawing funds from your RRSP, here’s what you need to know.

Registered Retirement Savings Plan: The basics

The RRSP is a registered account you can use to save for retirement. Other ways to save for retirement include:

Canada Pension Plan (CPP)
Tax-free savings account (TFSA)
Employer-sponsored defined contribution pension plan
Defined benefit pension plan
Group RRSP
Regular savings account
Direct investing in a non-registered investment account

The amount you can contribute to your registered retirement savings plan depends on the lesser of 18 percent of your prior year’s earned income, the annual RRSP limit, and other pension adjustments, where applicable. In 2024, the annual RRSP limit is $31,560.

Your RRSP contributions are tax-deferred. Also, you can claim tax deductions to reduce your taxes when you file your income tax return with the Canada Revenue Agency (CRA). The CRA taxes your RRSP withdrawals. One key benefit of saving through the registered retirement savings plan is that, with a lower marginal tax rate in retirement, you pay lower taxes on your RRSP withdrawals.

Withdrawing from your Registered Retirement Savings Plan

While you can withdraw from your registered retirement savings plan anytime, it’s not the best idea. The CRA requires financial institutions to withhold taxes on lump-sum withdrawals. Your taxes will depend on your marginal tax rate at the withdrawal time. Withdrawing money from your RRSP before retirement may lead to higher taxes and reduce your upkeep funds in retirement. An exception to this is if your net income has decreased significantly, causing you to fall into a relatively lower tax bracket at the time of your withdrawal.

Additionally, you should note that, unlike the tax-free savings account rules, withdrawing from your registered retirement savings plan does not free up additional RRSP contribution room. You lose out on tax benefits, contribution room, and the possibility of growing your retirement savings due to compounding interest.

If an emergency requires you to withdraw from your RRSP, ensure that your other sources of income in retirement, such as the Canada Pension Plan, Guaranteed Income Supplement (GIS), and Old Age Security (OAS) pension, are sufficient to provide for your daily financial needs when you retire.

Preparing for financial emergencies

An alternative to withdrawing from your registered retirement savings plan is using an emergency fund. An emergency fund provides a financial nest egg and helps to alleviate worries associated with financial emergencies.

The rule of thumb is to have an emergency fund covering up to six months of your expenses. However, saving up an emergency fund can take time. You can start by building an emergency fund covering up to one month of expenses. After completing this milestone, build your emergency fund until you have a buffer to fund a specific emergency or sustain you in the event of a job loss.

An emergency fund can help cover emergency healthcare expenses, pet expenses, or a job loss. Until a new job replacement, an emergency fund can cover your daily living expenses. It is important to rebuild an emergency fund after it has been used up; emergencies happen when you least expect them.

Using an emergency fund

Using your emergency fund for planned expenses, such as travel, buying a car, or even purchasing a house, is not recommended. If you need money to fund a home purchase, consider using the Home Buyers’ Plan (HBP), which allows Canadians to borrow up to $15,000 from their Registered Retirement Savings Plan to buy a home. It is important to note that the home buyers’ plan requires you to repay the withdrawals within 15 years following the withdrawal.

You can also pay for emergencies using your savings in a TFSA or non-registered investment account. A tax-free savings account allows you to save and grow money by investing in mutual funds, stocks, fixed-income assets, Guaranteed Investment Income (GICs), and Exchange-Traded Funds (ETFs). When you withdraw from your TFSA, you do not pay taxes. However, your realized investment income and withdrawals from a non-registered investment account will result in taxes to the CRA.

What to do when facing financial difficulties

Financial difficulties happen. Sometimes, planning only partially alleviates financial uncertainty. For example, there has been a lot of uncertainty around rising inflation and interest rates. The Bank of Canada has kept the policy interest rate at 5 percent to combat rising inflation rates. High inflation rates, measured by the consumer price index (CPI), reduce the purchasing power of your household income. Due to higher prices, your income can buy fewer quantities of the same items than it could have purchased a couple of years ago.

When facing financial difficulties, such as job loss, rising prices, or increasing debt, you can manage your finances by paying off high-cost debt, consolidating debt, budgeting for expenses, and being frugal. If you have high-interest debt, consider A debt management program, debt consolidation or refinancing. Speak to a financial advisor on the best option to tackle financial emergencies.

Summary

Registered Retirement Savings Plan withdrawals can help pay off debt or address financial emergencies. However, they may not be the best option.

Withdrawing from your RRSP results in taxes, losing retirement savings contribution room, and may distort your retirement plan. This is especially true for those closer to the retirement age. Consider other ways to manage debt and emergencies, such as seeking help from family and friends, debt refinancing and consolidation, or using money saved in your TFSA, savings account, or non-registered investment account.