Withholding taxes are unavoidable in your working years since, for most employees, they’re automatically deducted every pay period.
Being retired doesn’t exclude you from making remittances to the Canada Revenue Agency (CRA) on your retirement income, but there are more choices of how and when to pay the CRA that can impact your lifestyle.
Experts say the key is having a withdrawal strategy that considers your different retirement income sources and their tax rates, to keep more money in your pocket.
“You really have to think about cash flow planning when going into retirement, and where you’re going to draw from, to make sure you can pay your bills every month,” says Allison Marshall, vice-president of financial advisory support at RBC Wealth Management in Toronto.
“It takes a bit of thinking through when looking at sources that, while perhaps taxable, you may be better off withdrawing from based on the overall picture.”
Figuring out what to withdraw, and when, is a challenge for many Canadians. A 2019 CIBC poll shows 89 per cent of Canadians surveyed don’t fully understand how their retirement income is taxed. Nearly one-fifth of respondents believed the Canada Pension Plan (CPP) is a tax-free benefit.
Like employment income, most retirement income is taxable, including the CPP, Old Age Security (OAS) and company pension payments as well as registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs). With some retirement income, such as CPP and OAS, taxes aren’t automatically deducted with each payment, although it’s an option you can ask for to smooth out your finances and avoid a big year-end tax bill, which some experts recommend. Taxes are automatically withheld, however, on RRSP withdrawals, workplace pension income, annuity payments and, in some instances, on other sources — often causing some trepidation among new retirees.
“Clients often have an aversion to withholding tax, and that sometimes leads to an even bigger surprise when filing a return,” Ms. Marshall says.
It’s worthwhile for people to familiarize themselves with how withholding tax can work. For example, withholding tax rates increase depending on the size of a sum withdrawn from an RRSP: There’s a tax rate of 10 per cent on withdrawals up to $5,000; 20 per cent on withdrawals over $5,000 up to $15,000; and 30 per cent for withdrawals exceeding $15,000.
Financial institutions may increase the tax rate when more than one lump-sum withdrawal is made in a calendar year and withdrawals exceed in aggregate $5,000 or $15,000.
Still, it’s important not to assume this has happened, says Jason Heath, a certified financial planner with Objective Financial Partners Inc. in Markham, Ont.
“A lot of times people will try to take a few small withdrawals under $5,000 to only have 10 per cent withheld,” he says.
Then, upon filing, he says the actual tax payable on RRSP withdrawals gets calculated and the person could owe more tax.
Withholding tax doesn’t apply to the minimum annual withdrawal amount for an RRIF minimum, but it does apply to sums exceeding that threshold set by CRA.
Again, this can lead to tax surprises for retirees, particularly when they must convert their RRSP to an RRIF at the age of 71 and begin mandatory withdrawals at 72, Ms. Marshall says.
A bigger shock can come if net tax owing upon filing exceeds $3,000 ($1,800 in Quebec) for the year, and the two previous years, which can trigger the CRA requirement for them to pay quarterly instalments.
“It’s basically an estimate of tax for the year (divided into four payments) based on previous years of tax returns,” Mr. Heath says.
Retirees wanting to avoid instalments can request more tax be withheld from RRSP and RRIF withdrawals as well as pension plans and CPP and OAS, he says.
The decision of whether to pay more tax up front or owe more upon filing comes down to personal preference and can be managed with proper financial planning, says Grant White, a portfolio manager with Endeavour Wealth Management, Industrial Alliance Securities Inc. in Winnipeg.
“To some, it’s not a bad thing owing CRA at the end of the year because they’ve got an interest-free loan throughout the year,” he says. “At the same time, from a comfort standpoint, many retirees don’t like owing taxes upon filing.”
He says retirees can avoid a bigger tax bill when filing by aligning the amount of withholding tax they pay with expected income for the year.
“For most people, that’s setting withholding tax at 25 to 30 per cent,” Mr. White says. “For higher income earners, making $100,000 or more, they probably want to withhold more.”
Beyond retirement income sources, withholding tax can also apply to certain foreign assets, such as U.S. stock dividends and other income including funds generated from a rental property, when held in non-registered accounts.
Canadians should then file a T2209 Federal Foreign Tax Credits form with their return, which is used to calculate the amount of foreign tax you can deduct from your federal tax. Mr. Heath says it’s “an applicable tax credit you can use in Canada,” to avoid double-taxation.
The exception is when U.S. assets are in a tax-free savings account (TFSA) because a 15-per-cent withholding tax applies to dividends, which can’t be recovered.
In contrast, Canada’s treaty with the U.S. considers RRSPs and RRIFs as pensions, and therefore, the withholding tax doesn’t apply to dividends and other income, Ms. Marshall explains. As a result, RRSPs and RRIFs are often a better choice for foreign dividend-paying investments, she says.
In most cases, the bigger concern for retirees involves making sure withholding tax is accounted for in their overall income plan, Mr. Heath says.
“If you’re totally self-directed and do your own returns, it’s up to you to figure that out,” he adds. “But most people should be asking financial advisers for help.”