I am 52 years old and have $200,000 in my RRSP and $5,000 in my TFSA. I have a lot of unused TFSA room, but no new money to contribute. Does it make sense to withdraw some money from the RRSP each year, and then move it over to the TFSA? I realize the tax implications, so perhaps the best thing to do is always withdraw under $5,000 so I pay only 10% tax? My annual income is about $75,000. — Alex
There are situations when it might make sense to withdraw money from your RRSP and recontribute it to your TFSA. But these are rare, and Alex, I don’t think this is one of them.
You recognize that RRSP withdrawals are taxable, but I think you have underestimated the amount of tax you will pay. When you make an RRSP withdrawal of $5,000 or less, your brokerage is required to withhold 10% for income taxes. (The withholding tax rate is 20% on withdrawals between $5,001 and $15,000, and 30% on larger amounts. Rates are higher in Quebec.) But that doesn’t mean your total tax bill for the withdrawal is limited to 10%. When you file your return, the RRSP withdrawal will be added to your total income for the year, and you’ll owe taxes based on your marginal rate. If the withholding tax turns out to be insufficient to cover your liability, you still need to pay the rest.
For example, you mention your income is about $75,000. In Ontario in 2018, that would put you on the cusp of the fourth tax bracket. If you take an additional $5,000 from your RRSP (making your total income $80,000), you’ll owe 31.48% in taxes on the withdrawal, not 10%. So you would be left with just $3,426 to contribute to your TFSA.
It’s true that your $3,426 would then grow tax-free indefinitely in the TFSA, but it would take a long time to break even on this trade-off. Finding the precise breakeven point would require some complex calculations, though a financial planner should be able to help.
Withdrawing from your RRSP to contribute to a TFSA is likely to make sense only if you’re currently in the lowest tax bracket. In most provinces, that means a total income of no more than $35,000 to $45,000, including the amount you plan to withdraw. An ideal scenario might be if you’re taking a year’s sabbatical when you’ll earn no income. In that case, a withdrawal of up to $12,000 or so might incur no tax at all, so the full amount could go right back into your TFSA, where it would be sheltered from any further tax.
Just remember that money taken out of an RRSP (unlike withdrawals from a TFSA) are lost forever. You never get that contribution room back.
For the record, there are situations where it can make sense to do the opposite: that is, withdraw money from a TFSA and recontribute it to an RRSP. Consider a student who saved a few thousand dollars in her TFSA over several years of part-time employment. As soon as she graduates, she’s offered a high-paying job that will put her in a 45% tax bracket. If she has unused RRSP contribution room from her days as a part-time employee, she could take some cash out of her TFSA (with no tax consequences) and put it in her RRSP. A $5,000 contribution would get her a $2,250 tax refund, for example. Then she could roll that $2,250 right back in to the TFSA, or save it for next year’s RRSP contribution.
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