Understanding Withholding Tax in Retirement

Well, just because you retire does not mean that you will get away from withholding tax. Let’s take a look at withholding tax rates for withdrawals out of your RRSPs.

The basic rules

When taking money out of a registered plan like an RRSP or RRIF, withholding tax occurs at the same rates as lump sum single payments made to employees.

For periodic income payments out of a RRIF for example, there is no withholding tax until the minimum income is exceeded.

Differentiating between withholding tax rates and income tax rates

When it comes to taxes, it is only natural to try to pay as little tax as possible. I say it is part of human instinct. However, when it comes to withholding tax, it may not always be in your best interest to minimize withholding tax. The best way to illustrate this is to look at two twin brothers Larry and Ken.

Let’s say Larry and Ken both need $15,001 from their RRSPs in retirement to help pay for a trip to Europe with their respective wives.

Larry takes the $15,001 out at once. The financial institution is obligated to withhold 30%. This means that Larry would get $10,500 and there would be $4,500 remitted to CCRA on Larry’s behalf.

Ken takes a look at the withholding tax tables and decides that instead of taking $15,001 out at once, he is going to make 3 separate withdrawals of $5000. This way he is only subject to 10% withholding tax and he will get $13,500 instead of Larry’s $10,500.

While Ken may be ahead of the game initially, any withdrawals out of the RRSP must be taxed based on your marginal tax rates. If we assume that both Larry and Ken will be taxed at a 35% tax rate, here is what happens at the end of the year. Larry gets a tax slip saying that he took out $15,000 from his RRSPs and he will have to pay $5250 in tax. His tax slip also says that he has pre-paid $4500 in taxes so he still has outstanding tax owing in the amount of $750.

For Ken, he also gets the same tax slip saying that he must add $15,000 to his income and he will have to pay $5250 in tax. Ken however has only pre-paid $1500 in taxes so he will owe $3750 at tax time.

In the end, some might argue that Ken is better off because he has had the use of the tax money for part of the year. However, the point here is that you should not assume that withholding tax is the only tax that you will pay. If you utilize strategies to minimize withholding tax, remember that you may have to pay more tax at the end of the year.

Other things you need to understand

1. Payments. As mentioned earlier, periodic payments out of a RRIF or annuity is not subject to any withholding tax to the extent that the income does not exceed the minimum income. Once the minimum income is exceeded, only the amount above the minimum income is subject to withholding.
2. Withholding Tax Schedules. The withholding tax schedules are minimum withholding amounts. You can always ask to have more tax withheld at source but you cannot request less. Individuals, who are poor at budgeting, should consider more withholding at source. Ideally try to match the withholding rate to your marginal tax rate.
3. CPP/OAS. When it comes to your government benefits, you can also request more tax withheld at source. Withholding tax can apply to all sources of income and not just RRSP/RRIF income.

So there you have the basics on understanding withholding tax in retirement. Remember, you can’t avoid the tax; you can just plan properly to ensure that you do not get caught misunderstanding how withholding tax works.