Canadian investors are tapping into their RRSPs long before they retire, according to a recent Bank of Nova Scotia study on investment behaviour among adult Canadian investors.

Of the investors surveyed, 40% have made an average of three withdrawals from their RRSPs, The average withdrawal was $18,000.

For 37% of those surveyed, the top reason they cashed in RRSPs before retirement was to buy, build or get a mortgage on a new home. Also, 24% of those surveyed took out money to pay down debt and 20% took out money to cover living expenses.

Half of the investors who withdrew money do not intend to replace it. Ian Filderman, director of mutual funds at Toronto-based Scotiabank, says the number of people taking money out of RRSPs for lifestyle purposes is surprising, considering the cost of the tax hit.

“It’s an immediate hit,” Filderman says. “Between the withholding tax and the income tax, you get something substantially less than the amount you took out.”

Withdrawals from RRSPs under the Home Buyers’ Plan and the Lifelong Learning Plan are tax-free providing the full amounts are paid back on schedule. But other withdrawals must be included in income for that tax year and taxed as ordinary income.

A percentage is withheld by the financial institution to cover the tax. For withdrawals of up to $5,000, the federal withholding tax is 10%; for withdrawals between $5,000.01 and $15,000, it’s 20%; and for withdrawals of more than $15,000, the tax is 30%. The amount of the withdrawal and the taxes withheld are reported on the yearly tax return. If too much tax has been paid, a refund may be in order; if not enough has been paid, the taxpayer may have to dig deeper.

There are some good reasons to withdraw, says John Crisp, a Clarica Financial Services advisor in Victoria who specializes in pre- and post-retirement planning.

BETTER SOURCES OF CASH

“Anytime clients have an option to take money out of RRSPs tax-free or with little tax, I tell them to do it,” Crisp says. “RRSPs have some limitations and can be fully taxed later on. Once you’re retired and you have other income such as Canada Pension Plan or company pension plan benefits, there may be a higher tax rate when you withdraw money from your RRSPs than at the present.”

Sabbaticals, maternity or paternity leaves, and self-employment with dramatic income fluctuations from year to year can be ideal situations for withdrawing from RRSPs.

But too often there are sources of more appropriate income. “People need to do the math and make sure it’s the best option,” Filderman says. “There are other sources of capital, financing or restructuring debt to free up cash flow. These are avenues to explore first.”

Investors stand to lose much more than tax payments. Canadians expect to live 20 to 25 years beyond retirement, so they need more money than ever to support themselves.

“The even more serious issue is the foregone growth of the RRSP. That loss can be substantial,” Filderman says. “The risk of outliving money is very real. It means first of all, that Canadians need to put more money away. Second, they need to invest wisely and, if possible, not touch their RRSPs to allow them to grow on the compound, tax-deferred basis that makes RRSPs so powerful.”

Canadians are prematurely tapping into their RRSPs despite their lack of confidence in a financially secure retirement. The study found that among non-retired investors, 53% are worried they may outlive their retirement savings and 30% have yet to plan for retirement. IE