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Navigating the Withholding Tax Maze: A Comprehensive Guide

A frequent topic of discussion among investors pertains to the withdrawal of funds from a Registered Retirement Income Fund (RRIF). Many wonder about the implications of the withholding tax. This article aims to demystify how the withholding tax works, and how it impacts your personal finance journey.

Understanding Withholding Tax

In essence, a withholding tax is an amount that a financial institution is obliged to withhold from your RRIF withdrawal and remit to the Canada Revenue Agency (CRA) as prepaid tax. The withholding tax rates are structured in brackets: up to $5,000, the withholding rate is 10%; for amounts between $5,001 to $15,000, it is 20%, and for any amount over $15,000, it rises to 30%. Furthermore, you can request that we withhold more. I have a very old client. He has us withhold 50%.

However, does it matter if the institution withholds more or less tax than what your final obligation might be? The short answer is no.

Pay Now or Pay Later: The Taxman Cometh

The reason behind the insignificance of the amount withheld initially is that it ultimately comes down to a question of paying now or paying later. If the institution withholds less than your final tax liability, you will owe the remaining balance when you file your tax return in April. Conversely, if they withhold more than what you eventually owe, you’ll get a refund.

This principle extends beyond RRIFs to other forms of income like the Canada Pension Plan (CPP) and Old Age Security (OAS). If you don’t opt for tax to be withheld from these income sources, you will simply end up paying the owed tax in April when you file your return. In essence, whether it’s prepaid through withholding tax or paid at the time of filing, the tax must be paid. There is no penalty for withholding too little.

Example: Making Withholding Tax Work For You

Let’s illustrate this with an example. Suppose you want to withdraw $10,000 from your RRIF. Given the tax bracket, the financial institution is obligated to withhold 20%, or $2,000, leaving you with $8,000. However, if you need the full $10,000, you can “gross up” your withdrawal amount to account for the withholding tax, although this will result in a larger taxable withdrawal. of $12,500.

Now, you may be concerned about the withheld amount. Is it too much? Is it too little? The answer lies in your total income for the year, including government pensions. The key is not to fret about the withholding tax. If, in April, you find that too much was withheld, you’ll receive a refund. If too little was withheld, you simply pay the balance. Given the short time between December and April, it’s best not to lose sleep over the withholding tax.

Playing it Safe: Overpaying Your Withholding Tax

While mathematically it might make sense to aim for the withholding tax to exactly match your tax liability, there’s an argument for overpaying a bit for the sake of simplicity. Paying a little extra upfront can save you from a last-minute scramble in April, and any potential penalties associated with late payment. Remember, if CRA owes you a refund, they don’t care if you file late. To estimate your tax liability, you can use a tax calculator, such as the one provided by Ernst and Young, to calculate your anticipated tax based on your income. This is a great tool.

In Summary

In the end, understanding withholding tax is all about understanding your tax obligations. These are unavoidable, whether they’re paid upfront as withholding tax or later when you file your tax return. The choice between paying now or later is mostly about personal preference and peace of mind. By comprehending these aspects, you can confidently navigate the financial landscape and make informed decisions that fit your circumstances and financial goals.

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