By Everald Melbourne
The Caribbean Globe Financial Writer
BSc; ACCA, CPA, CGA; MBA
Topic: Financing Your Life
When you had a job with a steady income coming in, paying the bills was relatively simple; you didn’t really have to plan ahead because you knew the cash flow was going to continue.
Since there is no regular income, the thought of not having enough cash to pay the bills is perhaps causing you major stress. That is normal. Let’s look at some options you might have available to finance your life.
Do You Have an Emergency Fund?
It is advisable to set aside about three months’ worth of expenses in a bank account in case of emergencies. Barely anyone actually does that, so if you actually do have an emergency fund you are one of the picked few. If you have one, now is the time to use it.
Do You Have Any Savings?
If you don’t have any emergency funds sitting in a bank account, think about where your savings are—if you have any. Let us look at some of the various types of investments and the implications of pulling funds from them.
Tax-Free Savings Account (TFSA)
If you had contributed to a TFSA, the contributions were not tax deductible and any investment growth (interest, dividends, realized or unrealized capital gains) in the TFSA has not been taxed. You can take out any funds from a TFSA and pay no income tax on the withdrawal. If you have any money in your TFSA, it is probably the first place from where you should withdraw money.
Registered Retirement Savings Plan (RRSP)
The main function of RRSPs is to save for your retirement. However, you may need the money now because of your current financial situation. It would be better not to withdraw money from it, but your current situation may take priority over your retirement planning.
Nevertheless, the problem with taking money out of your RRSP to finance your expenses is that the amount is taxable. Unfortunately, it means that in addition to whatever salary you were paid during the current year, the RRSP withdrawal amount will be added to your tax return and taxed at your marginal tax rate. The timing of your exit from employment is therefore central when it comes to withdrawing money from your RRSP. If you are terminated at the end of January, you’ll get a T4 for only one month of income during that calendar year. Any RRSP withdrawal up to December 31st of that year will be in addition to only one month’s income, and therefore will be taxed at a low rate. If, however, you are terminated at the end of October, you’ll have 10 months of salary on your income tax return for that year. Any RRSP withdrawal during November and December of that year will be added to your 10 months of income and be taxed at a higher tax rate.
So if you left your job close to the end of the year, try and delay the withdrawal of your RRSP until January 1st of the next year, so the RRSP withdrawal amount will go on the next year’s tax return, which will be taxed at a lower rate.
The other problem with taking money out of your RRSP is that tax withholdings are required, the financial institution that holds your RRSP will hold back the tax and send it directly to the government on your behalf and you will only get an amount minus the withholding tax. This is fundamentally an estimate of what you will actually owe when you file your income tax return. The amount withheld will show on your tax return as taxes already remitted, much like the tax withheld from a pay cheque, and the actual tax owing will be calculated depending on all your other income. The withholding tax rates range from 10% to 30%, depending on how much you take out, for all provinces and territories except Quebec.
Note that when you file your tax return for the year of the RRSP withdrawal you could owe more than the withholding amount, but it could perhaps be less, depending on your total income for that year.
RRSP Withdrawal Exceptions
There are two ways you can get money out of your RRSP and not pay tax on the withdrawal:
(1) go back to school, or (2) buy a house.
Lifelong Learning Plan (LLP)
Both you and your spouse can take up to $20,000 each out of your RRSPs to pay for fulltime education or training expenses. The maximum you can take out each year is $10,000. You won’t have to pay tax on the amount as long as you pay it back over a period of 10 years. But if you are in a low tax bracket because you are not earning a salary, it probably makes more sense just to take the RRSP money out and use it rather than having to negotiate the LLP and then pay the money back into your RRSP.
RRSP Home Buyers Plan (HBP)
You and your spouse can each withdraw up to $25,000 from your RRSPs for a down payment on your first home under the HBP. You won’t pay tax on the withdrawal as long as you pay it back over the next 15 years.
The Canada Revenue Agency (CRA) has issued an alert warning taxpayers to be wary of offshore investment schemes or tax shelter arrangements that claim the RRSP withdrawal income from such schemes will not be taxable. Before you consider such a scheme, make sure you read the CRA Tax Alert which warns what can go wrong and also get independent legal and tax advice from professionals not connected to the scheme.
Unlocking Your Locked-In Pension Accounts
When your employment with a pension plan provider ends, it may be possible to have the plan value paid out instead of being transferred to a locked-in retirement account. This is usually allowed if the value of the plan is low or if you have a shortened life expectancy. To see if this is an option for you, contact the pension plan administrator.
Locking in simply means restricting access to the funds — you can’t simply withdraw the money because the government wants to limit it to the purpose for which it was intended. However, it may be possible to unlock the accounts so you can access the money now.
Federally Regulated Private Plans
Your plan is likely federally regulated if you work in aviation and airlines, banks, broadcasting, telecommunications, interprovincial transportation, railways, marine navigation and shipping. Private pension plans under federal jurisdiction are regulated by the Office of the Superintendent of Financial Institutions (OSFI).
If your plan is federally regulated and has already been transferred to a locked-in RRSP, locked-in Life Income Fund (LIF) or Restricted Life Income Fund (RLIF), it may be possible to unlock the funds under the following conditions:
1. Small Balance
If you are 55 or older with LIF holdings of less than 50% of the CPP Yearly Maximum Pensionable Earnings (YMPE) you can wind up your account and convert it to a tax-deferred savings vehicle like an RRSP or RRIF. The CPP YMPE is the maximum amount that CPP premiums are based on.
2. One-time 50%
If you are 55 or older, you are entitled to a one-time conversion of up to 50% of your locked-in funds value into a tax-deferred savings vehicle with no maximum withdrawal limits. In this case, the transfer to your own RRSP or RRIF does not require that you have RRSP contribution room and you are not taxed until you withdraw the funds from your RRSP or RRIF.
3. Financial Hardship
Withdrawals for financial hardship can generally be done once per year unless you have more than one locked-in account. If you only have one locked-in account and the maximum permitted amount was not taken out, another application for withdrawal can be made within 30 days of the first withdrawal. If you have more than one account, any second withdrawal must also be made within 30 days of the first withdrawal.
The permitted total amount of all withdrawals is limited to the following:
Low income: The amount you can take out is based on your expected net income for the year (line 236 on your income tax return). It varies from a withdrawal of 50% of the CPP YMPE
If you are no longer employed with the employer from which the pension funds originated and you have been a non-resident of Canada for at least two consecutive years, then you can unlock the total value of your plan funds.
5. Shortened Life Expectancy
If a physician has certified that you have a shortened life expectancy due to a mental or physical disability, the total value of your plan can be unlocked.
Provincially Regulated Plans
If your pension plan is provincially regulated, you’ll have to consult your provincial regulator for the unlocking rules.