Many Canadians dream of retiring early and with the right planning combined with smart investment decisions, a select few can make that dream come to life. Others aren't as lucky, and have found themselves faced with unemployment later in life - Statistics Canada reports that the unemployment rate for those over the age of 55 rose last month, and is at its highest in six years for women in that age group.
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Some could be considering an early retirement over finding a new job. But withdrawing money from your Registered Retirement Savings Plan (RRSP) early comes at a cost. Here are some considerations if you are thinking about retiring early.
If you have opened an RRSP, then you are aware that one of the most attractive elements of the government-registered fund is the tax incentives. But if you plan on dipping into your funds for something other than retiring, education or buying a home, you'll be faced with some heavy taxes.
If you need $5,000, you'll hand 10% of it back to the government as "punishment" for taking the money out - 5% if you're in Quebec. If you take more than $15,000 out of your account, you'll be penalized 30%.(Are you endangering your retirement? Find out in Top 6 Ways To Ruin Your Retirement.)
If you haven't made the maximum contribution each year to your RRSP, withdrawing funds early will also affect what you can contribute back into the RRSP down the line. When you withdraw money early, you aren't able to contribute back that same amount when you want to continue to invest. You will have lost that contribution room, which will change what you have to work with later on.
Loss of Control of Distributions
The most popular option for individuals who decide to retire and start using the money they've saved in an RRSP will be to transfer their money into an RRIF (Registered Retirement Income Fund). You will receive monthly payments from your RRIF which, at that point, will be subject to income tax. The amount you receive will be based on how much you have saved divided by an approximation of how many years you'll live. As a consequence, this number will be altered dramatically the earlier you retire.
For example, say Marie, a 52-year-old, has been laid off and is facing early retirement. If she has saved $200,000 and estimates that she will live to be 90, then she will divide the amount she has saved by the number of years she has left to figure out how much she will have to work with each month. In this case, she'll receive about $440 each month - which will be subject to income taxes.
Compare that to if she waited until she was 65 to retire. Even if she still had saved $200,000, she'd have an extra $230 each month to work with. That's aside from the extra money she would have saved in those additional thirteen years of contributions and interest.
Less Money over a Longer Time Period
This is the most obvious, but also the greatest disadvantage to retiring early. It's one thing to have to make your money go further over a longer time period, but you'll also have fewer years to let your RRSP grow to its full potential. You will have had less time to allow the funds to accumulate. Some cite the Rule of 72 in this case, which gives you an idea of how long it will take for an investment to double; depending on the interest rate, someone working for 15 year longer can have their funds double.
Say Marie, our 52-year-old retiree candidate, makes about 8% interest on her retirement investments, and her co-worker, Alan, is of the same age and has the same plan. If Marie retires at age 52, and Alan waits to retire at 61, Alan will have double what Marie will have to retire on based on the same initial amounts. Since, according to the Rule of 72, it takes nine years for an investment that earns 8% to double, Alan will be in a much better position once he stops working. (It's important to incorporate dividends into a portfolio - even if only on a small scale. To learn more, see Dependable Dividends.)
The Bottom Line
So even though dipping into your RRSP early or retiring early may be tempting, there are more than a few things to think about before you go ahead. Most importantly, long-term savings need long-term investments, and every year you enjoy as a retiree could make a huge impact on your future in the long run.
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