This year has had its ups and downs. Given the precarious nature of COVID-19, many sectors have faced a great deal of uncertainty due to ongoing shutdowns and government restrictions. As a result, many Canadians have had to exhaust all available options to avoid debt and financial disarray.
Financial hardships are never easy, and although it might be tempting to dip into your savings or drain your investment accounts, this can be a temporary fix that ends up being harmful in the long run. While it is hard to ignore the financial implications COVID-19 has had on the economy, you should always proceed with caution when making big financial decisions, especially if you withdraw funds from a tax-free account like a Registered Retirement Savings Plan. Should you decide to use your RRSP for COVID-19 relief, here are a couple of risks you may face:
The key to having a successful retirement plan is saving early. When you open a Registered Retirement Savings Plan, it automatically provides tax-sheltered savings for your future. According to the Ontario Securities Commission, more than half of Canadians over the age of 50 are without a retirement savings plan; the ones that do are often reliant solely on their RRSP or employer contributions.
Based on these stats alone, a lot of Canadian workers face financial uncertainty when it comes to their future, which is why opting to remove funds from your RRSP can have negative effects that might be hard to recover from. For instance, many government assistance programs that are aimed at helping retirees may not provide enough money for you to live comfortably. So, if you use your RRSP savings prematurely, you can ultimately delay your retirement since you will essentially be taking money away from your future self.
Although RRSP accounts are usually not locked, withdrawing funds can also cause you to permanently lose your contribution room. Your contribution room is the annual amount you can deposit into your RRSP. Once you remove money from your RRSP account, you will no longer have the ability to re-contribute for that year. The only instance when you don’t lose your contribution is when you withdraw funds for a Home Buyers’ Fund or a Lifelong Learning Plan. Anything outside these specific exceptions is subjected to high taxation and contribution loss.
Unwanted tax burdens
The most significant advantage of investing in an RRSP is it allows you to defer or minimize tax. Most people are generally in a higher tax bracket while working, so your RRSP contribution is deductible for income tax purposes. A Registered Retirement Saving Plan, unlike regular investment accounts, is not subjected to tax until funds are withdrawn because your income may be significantly lower once you retire. However, if you decided to use these funds prior to retiring, you will lose the opportunity to make valuable tax-free savings and high investment returns. Instead, you’ll gain unnecessary tax burdens since the money withdrawn from your account will be taxed at your current income, which is at a higher rate than had you waited until you retired.
Using your RRSP as a source of income or debt relief can seem like a good idea at first but it could end up costing you more in the long run. The funds released from your RRSP will be taxed alongside your regular income, causing you to pay more money in annual taxes. In some instances, the extra income earned from your RRSP can also reduce the money you receive from the Canada Child Benefit and GSTs.
When it comes to planning for the future, going through a financial crisis without an emergency fund can be extremely stressful. Although the government has provided programs like CERB and rent relief for small businesses, it can still cause a huge strain on your finances. Here at Moya Financial, we provide services to help you make smart financial decisions when times get tough. To learn more, contact us today!