Early RRSP withdrawals

I seem to have savings and taxes on the brain. I'm not sure whether this is because of yesterday's budget announcement, or Friday's RRSP contribution deadline. Either way, if you've been conscious at any point this month, you've probably been urged by someone to throw those piles of extra cash you have lying around into your RRSP.

While everyone's talking about getting money into RRSPs, I thought I'd look at the ways it's possible to take out your RRSP savings before retirement. Specifically, the HBP and LLP offer a way to do this when buying your first home, or pursuing post-secondary education, respectively.

Home Buyer's Plan

If you are a first-time home buyer, you can withdraw up to $20,000 from your RRSP, with no tax penalty, provided this money goes toward the purchase of a home within a specified time frame. You then have fifteen years to pay this money back in annual instalments into your RRSP. If you miss a year of catch-up contributions, then the amount of missed contributions is added to your taxable income, and taxed at your marginal rate.

Example

Suppose you withdraw $15,000 for a down payment under the HBP. You will then be required to pay back $1,000 per year to make up for the withdrawal over the next 15 years. If you miss a year, then $1,000 will be added to that year's taxable income.

You can look at this withdrawal as a loan you make to yourself from your retirement savings. There is no interest on this loan, except for the lost compounding on the funds you withdrew. If you withdraw $20,000 and pay it back over 15 years, then the value of those funds will be less than $20,000 in today's dollars. Hopefully you will make up the difference in home equity, but this is far from guaranteed.

Read more details on the HBP here.

Lifelong Learning Plan

If you are (or your spouse is) enrolled in (or planning to enrol in) post-secondary education, then you can withdraw up to $10,000 per year (up to a plan limit of $20,000) from your RRSP to cover educational expenses. You then have 10 years to pay this money back into your RRSP. As with the HBP, any missed catch-up contributions will be added to your taxable income.

Read more details on the LLP here.

Repayment

To pay back a withdrawal under either of these plans, you must complete Schedule 7, and include this with your tax return. The Schedule 7 designates a portion of your annual RRSP contributions as repayments to the HBP or LLP. These designated contributions will then not be included as deductions on your tax return.

Example

Suppose you have withdrawn $15,000 under the HBP, and make two RRSP contributions, one for $1,000 and one for $5,000. You would use Schedule 7 to designate $1,000 as an HBP repayment, and only the $5,000 would be included as a deduction on your tax return, even though you technically contributed $6,000 to your RRSP.

Note that the net tax consequence of making the $1,000 repayment and another $5,000 in RRSP contributions is to reduce your taxable income for the year by $5,000. This could also be accomplished by claiming the entire $6,000 as a deduction, and "missing" the $1,000 repayment: you would reduce taxable income by $6,000 for the contribution, and then increase it by $1,000 for the missed repayment.

Unless it bothers you to be "in arrears" on your repayments (to yourself), there doesn't seem to be much reason to claim a formal repayment on your tax return. The key is to ensure that your total RRSP contributions each year of your repayment period are greater than your required repayment amount.