Retirement Guide on MSN MoneySpring Retirement Guide
Sat, 12 Jan 2013 19:00:00 GMT | By Gordon Powers, MSN Money

Avoid dipping into RRSPs before retirement

Raiding your retirement savings to cover day-to-day living expenses is generally a poor choice.

Gordon Powers

If you thought that you were somewhat unprepared for a secure retirement, have a thought for those who have lost their jobs, warns the Transamerica Center for Retirement Studies.

In a bleak report, titled “The Cracked Nest Egg,” Transamerica estimates that more than half (51 per cent) of displaced workers have tapped into savings to make ends meet.

What’s worse, however, is that 35 per cent of them have also been dipping into their retirement accounts — despite the taxes and penalties that may apply. And that, unless they’re really strapped, will likely prove to be a mistake.

If you're planning on taking money out of an RRSP simply to pay some nagging bills, think again. In most instances, it's going to cost you a lot more than you realize.

First, there's the potential growth you give up. If you make a $5,000 withdrawal from your RRSP when you have 25 years to go before retirement, you'll give up $16,931 in retirement savings, assuming a five per cent return. The larger the amount and the younger you are, the more the damage.

Another significant problem with making RRSP withdrawals is that there's no way to retrieve the contribution room you used up when you put aside money in the first place. Granted, most people don’t use up all that room to begin with, but that doesn’t mean you won’t need it in the future. 

Keep in mind that RRSP cash is the most highly taxed money you can find. First off, tax is withheld at source and the amount depends on how much you actually withdraw, not your tax bracket.

For amounts up to $5,000, the rate is 10 per cent; from $5,001 to 15,000, it’s 20 per cent; and on amounts over $15,000, it’s 30 per cent.

But that’s not the whole story. The money you withdraw is also added on to all of your other income, often resulting in another tax bite the following April.

Say you withdraw $25,000. If your marginal rate was 40 per cent, then the total tax due on the withdrawal would actually be $10,000 — meaning, over and above the $7,500 you have already paid, you would owe the government an additional $2,500 ($10,000 – $7,500 = $2,500).

Does it ever make sense to withdraw money prematurely from an RRSP? Well, if your debts are increasing and you have little or no income to work with, maybe.


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