The main trick with using your RRSPs to your own advantage is to stop thinking of it as a back-up fund for those days when you really could use some ready cash.
For many people, rethinking the Registered Retirement Savings Plan riddle requires a mental switch. Your RRSP is not a piggy bank filled with pennies. Unlike a piggy bank, which will dispense a bit of change for a much needed chocolate bar, there is a payback system with RRSPs. You saved tax when you purchased them. Your own money earned you even more, while it sat interest-free in that fund and every time you cash them in, the taxman is waiting for his share.
"The worst thing you can do is to cash your RRSPs in for a rainy day expense. That's worse than a credit card," said Laszlo Szojka, of D.W. Good Investments.
Szojka explained that instead of cashing his own RRSPs when he needs a new muffler, for example, or even a new car, he uses his line of credit to purchase the needed item.
"I have some emergency money that is separate from my RRSP investments. But the main thing is, I use debt to my advantage – not to the bank's advantage," he said.
The government sponsored RRSPs are a program that's designed to allow citizens to save for retirement. The tax reduction is deductable from your income. If they are invested prudently, the compounding interest will grow and accumulate in your fund.
There are also government plans to help in the direst emergencies.
"There are also programs already in place for emergencies. For example, if you are working now but lose your job, there are Employment Income benefits, which in a way replaced the emergency fund. There is disability insurance that you can access if necessary," Szojka said.
For first-time homeowners, there is another advantage to RRSP savers because on a one-time basis, the government allows you to borrow interest-free from your own plan.
"For your first house, you can borrow up to $25,000 tax free from your own RRSP. If there is a couple, each person can borrow $25,000 tax free. Then over the next 15 years, you repay it to your own RRSP," Szojka said.
Szojka explained what would happen to the RRSP savings for the person who made a decision to spend $20,000 to purchase a new vehicle.
"The taxes would kill you," he said.
"Say you had an income of $50,000. The simplest way to look at it is you pay 32 per cent on that withdrawal, which amounts to $6,400 in taxes. So instead of having $20,000 for the truck, you have $13,600 for the vehicle. You've essentially paid 32 per cent income tax and killed your investment for the future," he said.
Cashing in an RRSP should be a well-thought out process that begins when your income is less.
Every situation is unique and you have to begin cashing it in when you turn 71 years of age and it must all be pulled out of the RRSP before age 75.
"There is a formula of how much income you have to cash in from your RRSP when you turn 71, but you don't want to cash it in too quickly. You don't want to cash it all in the first year," said Adam Klauwers, of Edward Jones, who said the principle goes back to the idea of saving a salary for yourself in your old age.
"RRSPs work exactly as if you had a paycheque. When you get a paycheque, you pay tax. Now when you withdraw it, think of it just like that paycheque, and you have to pay taxes on it. But you can set it up in many ways for yourself. If you've made sure there is enough in your RRSP savings, you can even set it up if you wish, like a salary or a paycheque," Klauwers said.
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