The Tax-Free Savings Account (TFSA) is a fantastic way to lower your taxes and save for the future. Unfortunately, it also complicates what was previously a simple decision. Before the TFSA was introduced in 2008 you deposited your savings in a Registered Retirement Savings Plan (RRSP) and went about your day. However, today there are potential benefits of using a TFSA instead of, or in addition to, an RRSP.

Unfortunately, there’s no way to transfer money from an RRSP to a TFSA without penalty. However, depending on your situation, the penalties may be minor. If you’ve deposited money into an RRSP and wish to move it to a TFSA, you’ll want to consider two things.

1. The taxes you’ll need to pay on the RRSP withdrawal

   • When you withdraw money from an RRSP, you must include that amount in your income for the year and pay taxes on it. For example, if you withdraw $10,000 from an RRSP and earn $50,000 from your job, your total income for the year will be $60,000. As a result, you’ll need to pay ~30% of the $10,000 you withdraw in taxes. This means you’ll only have $7,000 left to deposit into your TFSA.

2. The fact that you can’t redeposit that money to the RRSP in the future

   • With a TFSA, any withdrawal you make can be deposited back into the TFSA in a future year. However, with an RRSP, if you withdraw money you’re not able to redeposit that money in the future.

When it can make sense to transfer from an RRSP to a TFSA

1. Your income is currently low

   • If you’re taking time off from work, starting a business, or otherwise earning a low income this year, it may make sense to withdraw from your RRSP and move the money to a TFSA. If you withdraw $10,000 from an RRSP in a year where you’re not earning other income, you’ll pay minimal, if any, taxes. This may allow you to move the full $10,000 withdrawal into your TFSA. You’ll then be able to avoid paying any taxes on this money in the future.

2. You expect to have a higher income in retirement

   • If you expect to receive a pension from your employer when you retire, it may make sense to withdraw from your RRSP ahead of your retirement. If you combine a government pension, employer pension and withdrawals from an RRSP, your taxable income may be quite high. While this is a great problem to have, you may be able to lower your overall tax bill by transferring to your TFSA over time.

The process to move money from an RRSP to a TFSA

If either situation applies to you and you want to transfer money from your RRSP into a TFSA, there are three steps to take.

1. Request a withdrawal from your RRSP

   • You’ll need to have cash in your account to request a withdrawal. As a result, you may need to sell some of your investments ahead of time. You may be able to remain invested as you move money from your RRSP to your TFSA, however the process is more complicated. I recommend you contact your RRSP provider to discuss your options.

2. Pay the withholding tax on your withdrawal

   • When you withdraw money from an RRSP, the company that manages your account will keep a portion of the withdrawal for taxes. They’ll send this money on your behalf to the Canada Revenue Agency (CRA), like how your employer sends taxes from your paycheque.

   • Depending on the amount you withdraw, the company will withhold between 10% and 30% of the money.

     • $5,000 or less, they’ll withhold 10%

     • $5,001 to $15,000, they’ll withhold 20%

     • more than $15,000, they’ll withhold 30%

   • The amount withheld may not be the amount you owe when you file your taxes. It’s important to set aside some of the money for taxes in the future if you have a high income.

   • Withholding rates are slightly higher in Quebec.

3. Contribute the remaining money into your TFSA

   • Once you receive the money and have set some aside for future taxes, you can deposit the rest into your TFSA. You’ll want to make sure you have enough contribution room before starting the transfer process.

Closing remarks

While you can’t avoid penalties when withdrawing money from your RRSP, it may still be worth it. If the taxes you’ll owe are low, and you don’t need to redeposit the money to your RRSP in the future, then the penalties are minor. A simpler approach may be to leave the money in your RRSP and to start using a TFSA going forward. If you’re wondering whether you’d benefit from transferring money between accounts, you can consider connecting with an accountant or financial planner.

As always, thanks for stopping by the blog. If you’ve enjoyed this article, please consider subscribing to my email list in the footer to receive updates when new content is posted. If you know others who could benefit from the content throughout the site, please share the word, it’s much appreciated.