Tuesday, 26 January 2016

RRSPs are not just for retirement - 4 options to use your RRSP dollars

Even though the word "retirement" is one of the 4 words in the RRSP acronym, many savers may not know that an RRSP can be used for more than income in your twilight years.

The 4 options discussed will be:

  1. An emergency source of income in case of job loss.
  2. Home Buyer's Plan (HBP)
  3. Lifelong Learning Plan (LLP)
  4. Holding your mortgage inside your RRSP

If you lose your job, the 1st few months will feature severance payments and after that, there is Employment insurance.  Ideally, you should not touch your RRSP but if the unemployment drags on for 2 years, then you may need to get withdraw some RRSP monies, ideally when you are in the rock bottom tax bracket.  So to give you some idea of what to do, wait until the new calendar year after your EI and severance is nearing the end.  The basic personal exemption amount is $11,327 in 2015 and has increased to $11,474 ion 2016 so the first few months will be either tax free or minimal.  Once your withdrawals past the basic amount, then taxation starts.

Be aware that when you withdraw RRSP monies, there will be withholding tax.  The lump sum tax rates take effect here.  Under $5,000 is 10% tax, $5,000 to $15,000 is 20% and $15,000 and above is 30%.

Traditionally, financial advisors recommend taking out amounts in $5,000 chunks.

With the HBP, each member of a couple can withdraw up to $25,000 tax free in any calendar year to use as a down payment to buy or build a first house.  That's $50,000 per couple.  But there is a consequence with the HPP, you would need to pay back into your RRSP in 15 years in equal amounts of the amount your withdrew from your RRSP starting in the 2nd year.  If you miss a payment, that payment becomes taxable.

Similar to the HBP, the LLP lets you and your spouse withdraw up to $20,000 tax free ($10,000 max in any given calendar year) from your RRSP to enrol in a community college, university, or certain approved institutions of higher learning.  Since you are borrowing from your future self ( Marty McFly anyone) you must repay yourself, just like the HSP example.  In this case, you must repay in 10 years in equal amounts.

There is a fourth option that RRSPs make possible.  Holding your mortgage inside your RRSP.  An easy way to explain it would be to say "borrowing the money from your left pocket and lending it to your right pocket in the same pants"

So you have a $100,000 mortgage with a bank.  You also have $100,000 in RRSPs holding mutual funds (yuck) or other securities.  You could sell them inside the RRSP to create money inside your RRSP, arrange a private mortgage that can be used to pay off the bank mortgage, then make future mortgage payments to your RRPS (i.e yourself)

There will be costs to setup this up, rules about interest rates.  Check with your bank if they offer this service.  Also check with your investment and tax professional to see if this fits your financial needs.

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