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Dale Jackson

Personal Finance Columnist, Payback Time


Ah, summer. A time to live for today and worry about tomorrow, tomorrow.
That sort of freedom usually has a price, and if you’re thinking of dipping into your registered retirement savings plan (RRSP) for some summer fun, the tax sting could hurt worse than a sunburn. 
There’s nothing wrong with a little fun but there might be more tax efficient alternatives to raise short term cash.
If you are currently working full time, an RRSP withdrawal is probably the worst idea from a tax perspective. One of the Rs stands for retirement for a reason: they are designed to allow contributions to grow tax-free in the investments of your choice until they are withdrawn in retirement - ideally at a lower marginal tax rate.
In addition to tax-free growth, plan holders can benefit by contributing in years when their income is taxed at a higher marginal rate. If your highest marginal rate is 40 per cent, for example, you avoid paying a 40 per cent tax on your contribution the year it is made. If it is withdrawn at a 20 per cent marginal rate in retirement, you get huge tax savings.  
Early withdrawals not only deny the ability for that money to grow in investments over the years, but they will be taxed at a higher rate if your income is the same as it was when the contribution was made. That’s because the amount that is withdrawn is added to that year’s income. In other words, a contribution that resulted in a 40 per cent tax savings could be taxed at 50 per cent.    
It gets worse. Any RRSP withdrawal made by a plan holder under 65 years old is subject to an immediate withholding tax as high as 30 per cent. The maximum withholding tax applies to withdrawals over $15,000. It’s smaller for lower amounts and residents of Quebec.
If an early RRSP withdrawal pushes your marginal tax rate over 30 per cent, you will owe more than the 30 per cent withholding tax come tax time.
One more thing. Once you make an early RRSP withdrawal, you lose that allowable contribution room if you are looking for a tax shelter in future, higher income years. 
If you have suffered a loss of income and your marginal tax rate is lower as a result, you must still pay the withholding tax on early RRSP withdrawals. However, the final tax bill will be much lower because it will be taxed according to that year’s income regardless of your age. It just might be the lifeline you need to get through tough times. 
You can also avoid any tax if the funds are used to purchase a first home or go back to school (provided the funds are returned within a certain period of time).
It’s always good to have an emergency fund to dip into but that rarely happens in the real world. Besides, it doesn’t really make sense to have money sitting in cash when it could be generating returns.
Investing in a tax-free savings account (TFSA) is probably a better idea if you want quick cash. They are designed for short-term savings.
TFSA contributions cannot be deducted from your income like RRSPs but withdrawals, and any returns they generate are never taxed. There are contribution limits, so be sure to keep track.
Like an RRSP, you can hold a wide range of investments in a TFSA but if you expect to make early withdrawals avoid investments that require longer-term commitments.
There are no tax consequences from borrowing, but borrowing for a summer fling is usually a bad idea. The rapid rise in interest rates over the past 18 months has made it a worse idea. 
Interest rates on credit card balances can touch 30 per cent and consumer loan rates are in the mid teens.  
If you must borrow, and you own a home, a home equity line of credit (HELOC) normally has the lowest rates because it is secured against the equity in your home.
HELOC interest rates are still in the seven per cent range, which can really add up as it compounds over time.
Online debt calculators can put the true cost of borrowing in perspective, and might prompt you to find more affordable summer fun.