Witholding taxes can be incurred when you improperly withdraw from an RRSP.
For obvious reasons, investors should avoid RRSP witholding taxes whenever possible.
We've got you covered - this article will teach you everythign you need to know about RRSP witholding taxes.
What is RRSP?
RRSP is an acronym for Registered Retirement Savings Plan, introduced by the government in 1957 to help Canadians save for retirement.
It is a tax-advantaged account, which means RRSPs allow tax breaks on their contributions and help them save money. Therefore, any money you contribute to an RRSP today is exempt from CRA taxes and you will only be taxed the year you withdraw the money.
For example, let us assume you make $90,000 annually. The maximum allowable contribution in your RRSP is 18%, making the maximum amount that can be deposited into your RRSP, $16,200. Therefore, when filing your taxes, your taxable income will be your pre-tax income minus any RRSP contributions - $73,800.
RRSP is a tax-deferred account, which means you will have to pay taxes when you withdraw money during retirement. However, if you choose to withdraw money before your retirement, there are significant tax implications that must be considered.
As discussed earlier, when you contribute to an RRSP, it lowers your taxable income, which could also result in a tax refund.
When you decide to withdraw your money, the Canada Revenue Agency (CRA) will treat your withdrawals as ordinary taxable income.
What is RRSP Withholding Tax?
If you withdraw funds from your RRSP, your financial institution will withhold a percentage of the withdrawal and pay it to the government. This is known as the withholding tax.
Withholding tax is dependent on where you reside, and the amount of money withdrawn. The following table will illustrate the amount of withholding tax you will owe for early withdrawals.
- Up to $5,000: 10% for non-Quebec residents, 5% for Quebec residents
- Between $5,000 and up to $15,000: 20%, 10%
- Over $15,000: 30%, 15%
Note: If you live in Quebec, there is an additional 16% provisional tax that will be withheld.
Is there a penalty for withdrawing from your RRSP?
No, there is no penalty to withdraw from your RRSP, except for the taxes mentioned above.
What is the Impact of Withholding Tax on your withdrawals?
If you withdraw $25,000 from your RRSP and you are a Canadian resident, your withholding tax will be 30%. That means you will only receive $17,500 after initiating a withdrawal.
Will there be additional taxes after paying withholding taxes?
Depending on your income, you may have to pay additional taxes after the withholding tax is applied. When you withdraw from your RRSP, your financial institution will provide a T4-RRSP indicating the amount you withdrew, and how much tax was withheld.
At the end of the tax year, the amount you withdraw will have to be declared as income and could raise your tax burden. Make sure you are aware of all the consequences before you decide to withdraw any amount.
Will you get your Contribution Room back?
No, you will not get your contribution room back. Once money is withdrawn from an RRSP, it is not possible to add it back. For example, if you withdraw $10,000, you will not be able to add it later and you will lose the benefits of compound interest. For this reason, withdrawing from an RRSP must be your last resort.
How can I avoid Withholding Tax?
There are two situations when your RRSP withdrawals will not be taxed:
Home Buyers’ Plan: If you withdraw money to make a down payment on a home under the Home Buyers’ Plan (HBP), you can avoid withholding tax on your withdrawals.
The Home Buyers’ Plan allows you to withdraw up to $35,000 from your RRSP to buy or build a home, tax-free. It allows you to repay the funds withdrawn over 15 years, starting from the second year from the date of withdrawal.
The CRA will send a statement each year, stating the balance you owe, the total number of payments made, and the minimum payment required. If you wish to learn more about the criteria to qualify for HBP you can visit this link.
Lifelong Learning Plan: If you withdraw money for yourself or your spouse/partner for education or training on a full-time basis under the Lifelong Learning Plan (LLP), you can avoid withholding tax on your withdrawals.
All participants who withdraw from their RRSP under LLP are allowed a maximum $10,000 tax-free withdrawal per year, subject to a maximum combined total of $20,000. You can pay back the funds over 10 years and your repayments start from the fifth year after your first LLP withdrawal.
Any money that is withdrawn for reasons other than the ones stated above will be considered ordinary taxable income.
Why to Avoid Early Withdrawals from RRSP?
As discussed earlier, an RRSP account is your safety net for retirement. Unless you have an extreme emergency, early withdrawals from RRSP can have the following consequences:
Losing the Power of Compound Interest
When you decide to make an early withdrawal from your RRSP, you are also letting go of the power of compounding. For example, if you withdraw $10,000 today and your retirement is 20 years from now, assuming a mediocre annual return of 7%, you stand to lose over $38,697! This is a huge amount for a simple early withdrawal.
Withholding Taxes and Income Tax
Any early RRSP withdrawals will be subject to withholding taxes, which will be treated as income by the CRA and must be declared in the respective tax year. Your early withdrawals can lead to a high income tax bill, leaving you with less money in hand and more money to give to the government in the form of taxes.
Choosing Delayed Gratification
Retirement planning is all about making wise decisions for your future self while making small, consistent sacrifices today. If you choose to make an early withdrawal, you are robbing yourself of a better future during retirement, which is certainly not why you are working hard today. Choose delayed gratification over instant gratification for a better future.
Unless necessary, early RRSP withdrawals must be used as a last resort to avoid all the financial consequences associated with it. To gain a complete understanding about RRSPs, withholding taxes and any consequences related to early withdrawals, consult a finance professional for best results.