What is withholding tax? Understanding withholding tax in retirement - Retire Happy (2024)

Withholding taxes are a reality for all working Canadians. Withholding tax is the amount of tax taken off each paycheque and remitted to the Canada Revenue Agency (CRA) on your behalf.

Just because you retire does not mean you can get away from withholding tax. Let’s take a look at withholding tax rates forwithdrawals out of your RRSPs.

The basic rules of tax withholding

When withdrawing money from a registered plan like anRRSPorRRIF, withholding tax is deducted at the same rates as it would from an employee’s paycheque.

Note that for regular RRIF withdrawals, there is no withholding tax until theRRIF minimum incomeis exceeded.

Differentiating between withholding tax rates and income tax rates

When it comes to income taxes, it is only natural to try to pay as little federal income 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.

To illustrate this, let’s 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 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 the government 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 three separate withdrawals of $5000. This way, he is only subject to a 10% withholding tax and 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 yourmarginal 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 a tax bill in the amount of $750.

Ken 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, resulting in a $3750 tax liability.

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 thatyou 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 withholding tax issues you need to understand

1. Payments.As mentioned earlier, periodic payments from a RRIF or annuity are not subject to any withholding tax to the extent that the income does not exceed the annual minimum payment. Once the minimum payment 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 request more tax withheld at the 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 yourgovernment 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.

A note about withholding taxes on paycheques

As mentioned, employee paycheques are subject to withholding tax, and most employees accept the taxes withheld. However, employees can request an increase or decrease in the amount of income tax their employer withholds. If they find that they typically owe money at tax time, they may want to have more income tax deducted at source.

On the flip side, if they usually receive a large tax refund, they may want to reduce the amount of income tax deducted.

To increase your income tax deductions, you’ll need to fill out a revised TD1 form. To reduce your income tax deductions, you must complete Form T1213.

Final Thoughts on Withholding Tax

There you have it, the basics of 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.