Why cashing in your RRSPs is never a good idea

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By Jennifer Pritchett, Associate Editor

Dipping into your RRSPs before retirement is one of the worst financial mistakes a person can make — even after an accident leaves you unable to work, says Easy Legal Finance Inc. president and CEO Larry Herscu.

“This isn’t the same as taking money out of your savings account because those are taxable dollars. Taking it out of your registered plan is unwise and carries a significant long-term impact.”

Herscu comments on the issue as an increasing number of Canadians are deregistering their RRSP assets, a decision that saddles them with major tax implications.

A Bank of Montreal (BMO) survey conducted in 2016 found that 38 per cent of Canadians dip into their registered retirement savings plans early, up from 34 per cent the year before, reports the CBC.

According to the most recent poll of 1,500 people, conducted by Pollara and commissioned by BMO, a growing number of respondents are tapping into their RRSPs to keep their heads above water financially, says the national broadcaster. About 30 per cent of respondents said they cashed in early to buy a house, while more than one-fifth did so to pay living expenses, and 18 per cent said they did it to pay down debt, says the article.

The results of the BMO study are alarming when it comes to the number of people who are withdrawing from their RRSPs to pay for living expenses and to service debt, Herscu says.

“This only gets compounded in a situation where someone is injured in an accident and doesn’t have cash flow because they can’t work,” he says. “If they are already withdrawing from their savings to pay for their lifestyle and not to pay for rehabilitation to get back to work, it makes things even worse.”

While an accident can leave a person vulnerable to financial troubles, it’s important that individuals who are working through a settlement don’t resort to drastic measures such as cashing in RRSPs, Herscu says.

Easy Legal offers unsecured, non-recourse settlement loans to plaintiffs and their personal injury lawyers.

“We can provide financing, as a last resort, that allows you to leave investments for the future in place and eliminate the need to settle early,” Herscu says.

Cashing in an RRSP before age 71 will generally incur a penalty with Ottawa’s withholding tax alone reaching up to 30 per cent of the withdrawal and some provinces taking an additional portion, says the CBC.

“According to the BMO report, the average withdrawal was $17,213 last year, up by more than $1,300 in the past year. Unless it’s for a reason the CRA deems to be legitimate, such as to buy a home or to go to school, anyone who took out that much from their RRSP last year would lose $5,163.90 right off the bat to the federal withholding tax,” says the article.

Herscu says it’s also important to note any money taken out of an RRSP must be reported as income on your tax return, at which point you will have to pay additional tax.

“For example, if you remove $20,000, you are paying the 30 per cent withholding tax upfront so that reduces the amount of money you have access to by $6,000,” he says.

“Beyond the withholding tax, you’re losing the effect of the tax-free compounding that exists within a registered (financial) vehicle and even at a small compounded interest rate, the impact is significant. If you plug $20,000 into a growth calculator at five per cent interest for the period from the present to retirement, the amount is noteworthy.”

Using the Royal Bank growth calculator, $20,000 at five per cent over 20 years equals $53,065.

If you choose to cash in, it will come at a cost, Herscu says.

“Removing capital from an RRSP leaves someone without a plan B,” he says.

“It turns a bad situation into one of the worst you can find yourself in. It’s very difficult for someone to recover from this, so think twice before deciding to cash in retirement savings.”

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