Canadians can set-up a tax-sheltered registered account to save for retirement. This account was introduced by the Canadian Government in 1957 and is known as an RRSP account and people prefer contributing their savings in this account because of the numerous tax benefits it gives.
The Canada Revenue Agency (CRA) sets the rules governing annual contribution limits, contribution timings, and the type of assets and investments allowed in the RRSP.
RRSP stands for Registered Retirement Savings Plan. It is a tax-advantaged account, which means if you invest your funds in an RRSP you get tax-breaks from the CRA on the contribution amount. It is a type of investment account that allows you to hold several types of investments including shares, mutual funds, equities, bonds, and GICs.
The RRSP is a tax-deferred registered account
An RRSP account gives two main tax benefits. First, it is a tax-deferred plan. For example, if you earn $50,000 a year and you make a contribution of $9,000 in your RRSP account then the CRA will tax you only on your balance amount of $41,000 in that year.
Note that this doesn’t mean the account is tax-free. You will eventually have to pay taxes when you withdraw the money but at the time you will be retired and the tax rate will be lower.
Second, the growth of your RRSP investments is tax-sheltered. This means that if you invest your money through any other investment account, you are likely to pay tax on the profit or returns that you make from the investment. But if you invest through an RRSP account, you are exempted from any capital gain tax, dividend tax, or income tax, until withdrawal.
RRSPs are subjected to certain rules. One of the most important rules is regarding the amount of money you can contribute annually to your account. This is known as your RRSP contribution limit and it is 18% of your previous year’s income or a maximum amount, whichever is smaller.
You can withdraw from your RRSP account anytime but those withdrawals will be accounted for as income. So, you will be taxed on that amount at a higher rate than what you would have paid during your retirement and you will also be charged with a with-holding tax.
Further, you will lose that contribution room forever. However, there are two cases in which you can avoid paying this penalty to the CRA.
The Home Buyer’s Plan (HBP)
You can withdraw your RRSP money tax-free under the Home Buyers Plan and your RRSP issuer will not withhold tax. In the HBP, you can withdraw from your RRSP account to buy or build a qualifying home for yourself or a person with a disability. A qualifying house is a housing unit located in Canada which can be an existing home or one that is under construction.
According to Canada.ca, you can withdraw up to $35,000 from your RRSP under this plan as long as you are the owner of the account. Further, if you are buying a home with your spouse, you can withdraw $35,000 from each RRSP account. There are certain conditions you need to fulfill to be eligible to participate in the HBP:
- You must be a first-time homebuyer
- You must have a written agreement to buy or build a qualifying home.
- You must be a resident of Canada
- You must intend to occupy that house within one year after buying it or building it.
If you have owned a home before, you must atleast have a four-year gap from living in that house. For example, if you bought a house in 2012 and sold it in 2015, then you will have to wait until 2019 to use the HBP.
You must also repay your previous HBP money to be eligible for another program. You can pay the withdrawn money back within a 15-year period. Your repayment period starts from the second year after you first withdrew from your RRSP i.e. if you withdrew in 2017, you start repayments in 2019.
Payments will be divided each year. If you fail to repay your HBP, the outstanding balance will be added to your taxable income.
The Lifelong Learning Plan (LLP)
Another way to withdraw money tax-free from your RRSP is via the Lifelong Learning Plan (LLP). You can use previous RRSP contributions to finance full-time training or education for you, your spouse, or your common-law partner.
You cannot participate in the Lifelong Learning Plan to fund your children’s education. There are certain conditions that you need to fulfill to become eligible for an LLP:
- You must own an RRSP.
- The student is enrolled or has received an offer to enroll before March of the following year. Enrollment should be on a full-time basis, in a qualifying educational program at a designated educational institution.
- You must be a resident of Canada
- If you have made an LLP withdrawal in the previous year, your LLP repayment must not have begun.
You can withdraw up to $10,000 annually from your RRSP under the Lifelong Learning Plan and $20,000 in total. You can withdraw the amount until four years from your first withdrawal. For example, if you made your first withdrawal in 2016, you can withdraw until 2020.
You have up to 10 years to repay your LLP amount. Usually, you have to pay 1/10 of the total amount you withdrew until the full amount is repaid. The latest year you can start repaying your LLP withdrawals is the fifth year from your first withdrawal. If you pay more than necessary in one year, you are eligible to make a smaller payment in the following year.
You can take advantage of the Lifelong Learning Plan several times but you must repay the funds before you borrow from your RRSP again.
The Bullish takeaway
The Home Buyer’s Plan and the Lifelong Learning Plan are two unique provisions that help you withdraw from your RRSP without paying taxes to the CRA. You should also keep in mind that you will be using your retirement savings for another personal goal when you withdraw funds from this registered account.