Should You Use Your RRSP to Pay for a Renovation?
Understanding and effectively managing your finances can be quite daunting, especially if retirement plans and taxes are involved. This is why when it comes to leveraging your RRSP to pay for a renovation, you can find yourself scratching your head. You might be on a fence about whether to make a withdrawal and breathe life into your property or take a different approach?
According to a survey by BMO in 2018; 40% of Canadians withdrew an average of $20,952 from their RRSPs. But before you fill out that withdrawal form, use this blog post as a guiding light to find out if you should use RRSP funds to renovate your home. Plus, we will discuss an alternative approach towards this guide’s end if you decide against withdrawing RRSP. So that being said, let’s dive right in:
What is RRSP Exactly?
To make sure everybody reading this is on the same page as us, you must have a clear idea of RRSP. Short for Registered Retirement Savings Plan, an RRSP is a great way to save money for when you retire. Plus, your investments are not taxed as long as they are in the RRSP.The best part is; you don’t even have to be near retirement or over 18 to have RRSP. People under 18 with SIN and regular tax return filings can have RRSP. Canadians can hold a range of investments within their RRSPs and some of the most common ones are:
- Bonds (corporate/government)
- Mutual Funds
- Index Funds
- Gold and silver bars
- Major Canadian Foreign Exchange Stocks
- Savings bonds
- Income trusts
Here are some common investments you cannot hold in your RRSP:
- Precious metals
- Personal property like gems or art
- Commodity futures contracts
- Shares in real estate and private holding companies
- You can keep your RRSP active until the 31st December of the year you turn 71. After that, you can convert it into an RRIF or Registered Retirement Income Fund to make further money out of your funds.
So…..Should You Use RRSP to Pay for Renovation?
Before you even entertain the thought of using RRSP, you need to find out if your RRSP funds are even accessible or not. If the RRSP is locked in, you cannot withdraw funds until they are matured, like many types of insurance policies.
So if you don’t know this, contact your RRSP issuer and ask them first. If the RRSP is not locked, you can then contemplate withdrawing funds.
Now let’s address the BIG question; should I use RRSP for renovation or not? Well, we cannot be the ones to give you a straightforward ‘Yes’ or ‘No.’ However, we can lay down some facts; you can then be the judge:
- There Are Withholding Taxes: When we say ‘taxes,’ we mean a big chunk of your funds will go to the government when you make the withdrawal. Whether you are making post-retirement RRSP withdrawals or while you’re still employed, you’ll have to pay 5-30% withholding tax depending on the amount and your location.
- You’ll Pay Income Tax: Besides the withholding tax and some additional charges from your RRSP issuer, you will have to report the withdrawn funds on your tax return as your income. You may end up paying more taxes now if your retirement income is lower than your current income.
- Losing Out on Tax-Sheltered Compounding: If you withdraw funds, even just one time and even if it’s a very small amount, you will lose money in the future. This is because you will take out ‘tax-free’ money, which would’ve compounded to something significant in the future.
- Loss of Contribution Room: Although you can continue contributing money to RRSP in the future, you will not be able to put back the same amount you withdrew and will permanently lose that contribution room. This will reduce your RRSP’s potential value at the time of retirement.
Bottom Line: Yes, it seems very lucrative to take out as much money as you need for renovations from RRSP. However, you can potentially lose a big chunk in taxes and compounding if you take out your RRSP funds now.
But….What About RRSP Withdrawal for Home Buyers’ Plan?
Many people think the Home Buyers’ Plan is the back door that they can use to get money for renovations. This is because according to RRSP withdrawal rules; funds taken out for home buyers’ plans are tax-free.
However, you cannot get it for general renovations because it is only granted when you are purchasing a property for the first time.
Plus, the home buyers’ plan comes with its own caveats, like replenishing the withdrawn funds within 15 years. If you fail to do so, you’ll then have to pay the taxes.
Don’t Fret; There’s a Better Alternative:
If you’ve read it this far, then it means you are not leaning towards withdrawing your RRSP funds for home renovations. Well, we won’t leave you high and dry; the solution to your problem is a ‘Home Equity Loan.’
It’s basically borrowing a percentage of your home’s total value minus the amount you owe on your mortgage. The resulting amount represents your home’s equity. Be it $10,000 or $200,000; you can easily get the funds you need for overhauls.
The amount you receive from a home equity loan can be used for anything, whether you need to renovate just the bathroom or the entire home; you can do just that! Plus, you can even buy another property, put it on rent, and use that money to pay back to the lenders.
Since you need funds right now and have access to a big chunk of money, you can quickly forget that it is compounding under the tax-shelter. And taking it out can result in withholding and income taxes.
Plus, you will lose out on tax-deferred compounding, which will set you back a few thousand bucks in the future. So we suggest you only take the money out if you can digest the future loss of funds and pay hefty taxes right now. Otherwise, go for alternatives like home equity loans.