Dipping into your RRSP: costly now, and very costly down the road
From a financial planning perspective, a challenge arises from time to time: striking the right balance between short-term and long-term objectives. While the former often target concrete, “fun” goals—a great vacation opportunity, buying a luxury car or even a boat, etc.—the latter are a harder sell, since they generally have to do with more intangible considerations, such as financial security for a retirement that may still be a long way off.
This is why it can be tempting to satisfy the urge of short-term exhilaration and withdraw from a savings account intended for long-term financial security, such as a group RRSP.
However, dipping into your RRSP before retirement comes with financial consequences, both now and later. It’s as if you were actually double dipping (which is always frowned upon!).
Why is it costly now?
In addition to a withdrawal fee, an early withdrawal from your group RRSP will cause you to pay more income taxes, as your income is higher now than in retirement.
For example, if your income is $50,000 and you want to withdraw a net amount of $2,000, in fact, you may need to withdraw more than $2,800 now (more than $800 of withholding taxes) compared to approximately $2,500 at retirement (approximately $500 of withholding taxes), since your income and marginal tax rate will be lower then. i
Why is it even more costly in retirement?
Your group RRSP is designed to help you save for retirement. Using it to fulfill present-day financial needs will set back your chances of reaching your retirement goals.
Still using the example above, if the $2,000 net withdrawal occurs at age 30, the actual amount withdrawn—more than $2,800—would have resulted in approximately $11,000 in savings by age 65, taking into account compound interest and based on an estimated annual rate of return of 5%. In short, in this example, making such an early withdrawal from your RRSP would reduce your annual retirement income by $600.
What’s more, if the employer contributes to the group RRSP, withdrawals of employer contributions can be subject to a penalty, and you won’t get back the lost RRSP contribution room the following year.
Making up for an early withdrawal ends up costing a lot later on
To make up for withdrawing a certain amount at age 30, you’ll need to contribute more than twice that amount at age 50 to accumulate the same savings and retirement income by age 65.
| Amount saved | At age | Worth at age 65 ii |
| $2,000 | 30 | $11,000 |
| $5,300 | 50 | $11,000 |
Strategies to avoid withdrawing from your group RRSP
If withdrawals are due to financial constraints:
- If your plan allows it, consider temporarily adjusting your contribution rate or amount rather than withdrawing already invested funds.
- See if you can reduce your debt payments (e.g., mortgage) until your financial situation returns to normal.
- Consolidate your debts with a single financial institution to potentially lower your interest costs and monthly payments.
If the withdrawals are related to unexpected expenses:
- Prepare and follow a budget so you can be aware of your income and expenses, and set aside an amount for unplanned purchases or rewards on special occasions.
- Ask yourself, before buying something: Does that product or service meet a need or a want? Could I do without it?
- Before buying the latest product, sleep on it and see if the need persists.
Other strategies:
- Consider having a line of credit.
- Consult an advisor who can help you identify the best strategies for you.
i Using a hypothetical example based on a retirement income equal to 70% of pre-retirement income, a percentage often recommended to maintain a similar lifestyle in retirement. Every person’s situation is different, and the tax rate varies by jurisdiction (e.g., a province) and from year to year. Be sure to inquire about the specific details that apply to your situation.
ii Rounded amount based on an estimated annual rate of return of 5%.