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RRSPs: Hands Off or Hands In?

Written by Posted On Tuesday, 04 March 2003 00:00

As the annual scramble to stash cash in RRSPs ends, the debate rages on. Should Canadians mentally post a big "Hands Off" sign on their RRSPs? Or should they consider their Registered Retirement Savings Plan (RRSP) a "registered ready-spending plan," there to help out in a cash crunch?

Say ‘yes,' to the first question if you agree with the government's original intention: to encourage Canadians to save for their retirement. This side of the debate concentrates on the benefits of compound interest, tax deferment and income tax deductions. You leave your RRSP contributions untouched so that the magic of compound interest, or interest on interest, augments your savings to finance decades of retirement.

If you said "yes" to the other side of the RRSP debate, you may see more immediate uses for some or all of your RRSP savings. Property owners know the "invoice" shock for an unexpected new roof, furnace replacement or major water-damage clean-up and the necessity of turning to cash reserves – any cash reserves.

One Montreal financial advisor, who promotes RRSP saving, sees RRSPs this way: "They are not sacred, but people tend to misconstrue the purpose. It is just money and, just like any other money, use it as a tool. You have to look after today before you can look after tomorrow. I would just about always, think first that the RRSP is tax-deferred savings and a tax deduction, but if the situation becomes a bit unusual there is room to be creative.

"The RRSP is one of your sources of capital at any time. You always want to have some liquidity in there to some degree. For people who have less liquidity, [their RRSP] will be one of their first lines of defense."

According to Statistics Canada, Canadians under 65 years of age cashed-in about one dollar of RRSP savings for every five dollars contributed. They use RRSP funds to return to school, buy a home, renovate, start a home-based business or bounce-back in an emergency.

We find the federal government on this side of the debate, too. The Canada Customs and Revenue Agency (CCRA) allows tax-free RRSP withdrawals to finance full-time education for you or your spouse, with the total withdrawal not to exceed $20,000 over four calendar years. Funds must be returned to the RRSP over a ten-year period or the withdrawal will be considered taxable income.

The CCRA's other RRSP withdrawal program, The Home Buyers' Plan, (See "HBP Funds Available To Buy or Build Accessible Homes ") has been the subject of previous columns. You and your spouse may withdraw up to $20,000 each to buy or build a home if you qualify. The RRSP must be repaid at a minium rate of 1/15 of the debt per year or the amount withdrawn becomes taxable income.

Although the funds may be used to invest in a home, RRSPs may not be used as collateral.

To decide whether to withdraw funds -- in or out of a government program -- to invest in real estate or anything else, evaluate the proposed investment and compare the cost of borrowing from a number of sources. The return earned on the investment should exceed the cost of RRSP withdrawal.

It's a temptation to grab the RRSP funds before thoroughly investigating your options. Using your RRSP as a "registered ready-spending plan" also carries some income tax cautions: [bullet] Any funds withdrawn outside of a CCRA program become taxable income that year, which may move you into a higher tax bracket, increasing the tax hit.

  • Even if your RRSP may be cashed in before maturity, you will not get all the money you withdraw since a percentage is withheld for income tax.
  • Even if the money may be replaced, you will have lost some of the benefits of compounding power in the meantime.
  • If you withdraw within a government plan, also consider possible tax costs of RRSP non-repayment.
  • In all cases, remember that investment losses are not allowable tax deductions within an RRSP.

Talk to your financial advisor to determine what tax implications you face.

And the debate continues...

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