Cashing in or cashing out?

Deciding when and how and even if you should cash in Registered Retirement Savings is the question. Whether it is nobler to hang onto those savings and make money on the compound interest or whether it is best to cash in your RRSPs, even while suffering the slings and arrows of taxes, ay, there’s the rub. If you don’t figure out how much those cashed in RRSP funds will add to your income this year, the taxes could darned near kill you. If you get the formula right, you could perchance be living the retiree’s dream.

The answer isn’t that simple because there is no blanket answer that fits every person’s personal financial situation, said Laszlo Szojka, a financial advisor at D.W. Good Investment Company. The danger for many people is taking their funds from their RRSPs and using those savings to purchase a new car or to pay off debts.

“You have to start by understanding what the acronym RRSP means. The main word in there is ‘retirement’ because it’s meant to be savings that you put away for yourself until you are retired, which for most people is 65. It’s not a savings, cash and go account,” Szojka said.

As a simple first step, Szojka suggests anyone considering cashing in funds from an RRSP account should calculate what those funds will add to their current income. Next they should look at a tax rate chart to see what their combined federal and provincial tax rates will be for their income level.

“Where people mess up is they cash out their RRSPs too quickly and they may cash out too much at once,” Szojka said.

Szojka offered the extreme hypothetical example of the man who cashed in $100,000 all at once so he could go on a holiday soon after retirement. The cash-in would cost the man more in taxes than his total income for that year.

“At retirement, his income which includes his pension, Canada Pension and Old Age Security may be $42,000. With that income, he would then pay 25 per cent of it in taxes. Add $100,000 and he now has an income of $142,000 so he is in the 39 per cent income tax bracket. And where it really gets nasty, he loses his Old Age Security income for a year because he made too much money,” Szojka.

When you take out an RRSP in a given year, the government does not tax you on those savings – at first. The government must always get those taxes, but they allow you to invest the funds and hopefully grow the money and then defer the taxes until you retire. When you retire, you will likely be in a lower tax bracket category, and therefore you will pay less at that time, when you pull out your funds.

The instant you cash in RRSP funds, there is an immediate tax to pay of 10 per cent. At the end of April, you must pay the difference up to the income tax level of your yearly income.

Szojka recommends that anyone nearing age 65 should carefully consider the benefits of tax-free savings accounts as well as consult investment experts and tax accountants on how best to move to Registered Retirement Income Funds.

“It becomes a tax planning issue. You must consider what do you need the income for. When you retire, you may wish to convert to a RRIF to draw income out at a monthly rate,” he said.

You will pay tax according to your income then, but whatever you do, don’t cash in RRSPs to pay debts, Szojka advised.

“RRSPs may offer the ultimate financial freedom but not if you rob from your own retirement funds. Don’t rob from your future because you never know what may happen and you cannot rely on the government to look after you. They may change the rules,” he said.