What Is the Penalty for Cashing in an RRSP Early?

Registered Retirement Savings Plans offer tax-deferred savings for Canadians.

Registered Retirement Savings Plans offer tax-deferred savings for Canadians.

Registered Retirement Savings Plans provide tax benefits for Canadians who save for retirement. The accounts are designed to be held until retirement, but many taxpayers need their money earlier to cover expenses, such as financing the purchase of a home or automobile. Contributions and deductions to your RRSP are limited each year. You may carry over your unused contributions into a future tax year.

Income Tax

Early withdrawal eliminates the tax advantages of an RRSP. Withdrawals are taxable in the year you withdraw. Interest, dividends and capital gains on investment appreciation also become taxable as soon as they are withdrawn. It is not usually a problem if you wait until retirement to begin taking your withdrawals because you will be in a lower tax bracket at that point in your life. However, it can create a significant tax liability if you withdraw funds during the prime earning years of your career. A provincial tax also applies if you live in Quebec. You may transfer funds to another RRSP without incurring any tax liability.

Loss in Future Earnings

The main benefit of a retirement savings plan is the power of compounding interest. Withdrawing funds from your account prematurely reduces the principal that will be used to generate interest in the future. You will have a much smaller amount to purchase an annuity at retirement, reducing your monthly payments for the rest of your life. Over the long run, the cost to you will be significantly more than just the amount of the withdrawal.

Surrender Charges

You are allowed to choose the investments within your RRSP account, such as mutual funds, stocks or bonds. These investments may impose their own surrender charges if you cash out early. If you purchased securities through a broker, you may also have to pay early withdrawal fees to the brokerage house. Combined with the compound interest you lose by withdrawing early, these fees can be devastating to your portfolio.

Locked-In RRSP

Money in a locked-in RRSP may not be withdrawn early. You must leave your funds in the account until you retire, then you will receive monthly annuity payments. Locked-in RRSPs arise when an employee leaves an employer-sponsored Registered Retirement Plan before retirement age. If your account is fully vested on the date you quit working for the company, your funds will be transferred directly into a locked-in RRSP. The vesting schedule depends on the provisions of your employer's plan. Most accounts vest fully after two to five years of employment.


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