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How to keep your RRSP mojo even if you’ve lost your job

You've been working hard to pay down debt and save for retirement. Then you get the news: You're losing your job and joining the ranks of the estimated 1.3 million unemployed Canadians.

So much for "Freedom 55."

Loss of a job can put a serious wrinkle in even the best-laid retirement plan, financial advisers say. With a reduced household income, or perhaps no income at all, feathering that nest egg usually moves down on the list of financial priorities. Tough decisions need to be made, including perhaps raiding a registered retirement savings plan to fund living expenses.

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"This is a challenging time. Your life situation has changed dramatically, and suddenly you have to make all these decisions," says Robin Muir, a principal at Hatch & Muir LLP, a Victoria financial planning firm.

For those leaving work with a severance package, the first decision is what to do with the money. Pay off debts, or put the entire thing into an RRSP to minimize tax liabilities?

Timing is everything in this case, says Sylvia Sarkus, a Toronto-based, for-fee certified financial planner. The severance amount could push the employee into a higher income tax bracket for the year. Putting all or some of that money into an RRSP could certainly trim the tax bill.

But even then, there's no rush to invest the full amount, Ms. Sarkus says. "Remember that you can contribute to an RRSP up to 60 days after the end of the calendar year," she says. "So you don't have to stick it in all at once."

Also, how much cash will you need to stay afloat until you find another job? A cash reserve that covers between three to six months' worth of expenses is ideal, she says. This money should be kept in an accessible account such as a daily interest short-term deposit account, and not in an RRSP.

Older employees who lose their jobs and receive severance should also be aware of rules that allow them to roll over part of their severance plan into an RRSP, above their contribution limits. Employees can transfer to an RRSP up to $2,000 of their severance for each year before 1996 that they worked for the company issuing the payout, says Dora Mariani, a principal in the tax group of Toronto accounting firm Segal LLP.

Employees who worked for a company without a pension plan prior to 1989 can also transfer an additional $1,500 for each year of employment with that company before 1989, says Ms. Mariani.

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"But keep in mind that the transfer isn't done automatically by the employer. The employee has to put the money into the RRSP or request that the employer transfer the amount directly to the RRSP," she adds. "Also, this is a one-time thing – that eligible contribution amount does not carry forward, and you have only until the usual RRSP contribution deadline to use it."

For other out-of-work Canadians, the big question may be less about where to park severance money but more about how to cover living expenses. If they have an RRSP and no job prospects on the horizon, it may become tempting – and necessary – to withdraw the money that has been saved for retirement.

They should explore other options before taking this step, says Rob McGavin, managing director of financial planning and advisory services at Bank of Nova Scotia.

While an RRSP withdrawal within the basic personal tax credit – about $11,000 today – isn't taxed, anything above that amount will be, says Mr. McGavin. What's more, under RRSP rules you can't put that money back in once you start working again because you've already used that contribution room, he adds.

"But if you are faced with that difficult decision, sometimes [withdrawing from an RRSP] is the only option people have," Mr. McGavin says.

Pulling out RRSP cash under these circumstances needn't be a glum decision. Some people use the money to go back to school to refresh skills or pick up new ones, Mr. Muir says. Under the Lifelong Learning Plan, Canadians can make a tax-free RRSP withdrawal to fund education for themselves, a spouse or common-law partner as long they return the money within 10 years.

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Some people also have strategic investment reasons for taking money out of their RRSPs when they're unemployed, says Ms. Mariani. As an example, she cites a situation where a spouse leaves the work force for a few years to raise the kids and the other spouse makes more than enough to cover all living expenses.

During this time, the couple decides to withdraw up to $11,000 of the unemployed spouse's RRSP – or whatever the amount is that would remain untaxed under the personal tax exemption rule – and invest the money within a tax-free savings account.

By keeping the RRSP withdrawal within the personal exemption limit, the couple is able to withdraw, without incurring a tax bill, money that had already provided them with a tax deferral when it was first put into an RRSP. This step, in essence, turns the tax deferral into a true tax savings.

Investing this RRSP cash within a TFSA provides a further tax advantage because TFSA withdrawals aren't taxed.

"It makes sense," says Ms. Mariani. "If one spouse is working and can support the family, and assuming there's TFSA contribution room, it's a good strategy."

For the committed savers who want to continue contributing to their RRSP while they're unemployed, even with just $50 a month, Ms. Mariani has this to say: It's not a bad idea. There are benefits to doing this, she says, including creating tax deductions that can be carried forward to a higher-income year.

But take care not to exceed your RRSP contribution limit. Unemployed workers who regularly maxed out RRSP contributions may not have enough room to contribute if they're out of work for more than a year, she says. "Employment insurance income is not earned income and does not build RRSP contribution room," she says.

Whether they keep up or put a hold on their RRSP contributions, out-of-work investors should review their portfolio strategy against their current tolerance for risk, says Mr. Muir at Hatch & Muir.

"With the change in your job situation and given your lack of income, you may not be able to stomach the risks associated with your current investment," he says. "So make sure you go through a new risk assessment and make adjustments if you need to."

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