An RRSP is a registered retirement savings plan that allows you to build a nest egg for the future. It lets you set money aside to invest in the market for your future retirement.
Since it’s a savings plan, you can invest your money, and it grows tax-free until it’s withdrawn.
When you save in an RRSP, you can invest in different options like ETFs and mutual funds.
You can defer paying income tax on dividends, interest, or capital gains you earn in the RRSP. The investments stay in the RRSP while you’re saving for retirement.
However, income tax will be withheld when you take money out of your RRSP. The amounts withdrawn will be added to your income for the year, increasing your taxes.
This article covers everything about withholding tax RRSP and how you can avoid paying withdrawal taxes.
How RRSP Works in Canada?
The Registered Retirement Savings Plan (RRSP) is a type of savings plan that helps Canadians save money for the future and prepare for retirement.
Similar to a regular investment plan, such as a mutual fund or stock, an RRSP is just another way to save for your long-term future needs.
An RRSP allows individuals to save and invest on a tax-sheltered basis while deferring taxation on accumulated capital gains until the plan is withdrawn.
You can plan for a comfortable retirement with the help of RRSPs. The funds can be invested in different investment vehicles and distributed tax-free to the contributor while they are still working.
Furthermore, all RRSP earnings, whether capital gains or interest, are tax-free.
However, a person must liquidate an RRSP and convert it to a registered retirement income fund when they reach the age of 71.
Although, there is no minimum age for contributing to an RRSP. You can only do so after having earned income from employment and having filed your taxes.
RRSP Contribution Room
Your RRSP contribution room is the maximum amount of money you can contribute to your RRSP tax-free in a given year.
This amount varies from year to year and is calculated based on the unused room of the previous year and your earned income.
The RRSP contribution room is set every year by Canada Revenue Agency (CRA). $29,210 is the contribution limit for 2022.
However, a person with an income of 18% pre-tax but less than the contribution limit of the current year can contribute based on the annual contribution limit.
As a result, you may expand your contribution limit each year by improving your earnings and carrying over your new contribution limit.
RRSP Withdrawal Rules
The following are the two major withdrawal rules when you decide to take money out of your RRSP account:
- When you withdraw funds from your RRSP before reaching the age of 71, it will be taxed as income in the year the funds are withdrawn. However, there are no tax consequences when you withdraw funds to pay for the first-time purchase of your first home or fund the Lifelong Learning Plan (LLP).
- Withdrawals from an RRSP before the end of the contribution period forfeit the contribution room forever.
Consequences of Withdrawing RRSP Before Maturity
The most obvious consequence of prematurely withdrawing funds from an RRSP is a tax penalty.
Withdrawing a large amount can increase your tax bill since you’re paying withdrawal taxes in addition to combined income taxes.
However, did you know there is another huge consequence to early withdrawals?
It’s a simple fact that all you are doing is depriving yourself of the money you’ll need in retirement.
A long-term, steady contribution to a retirement plan allows funds to grow thanks to compound interest.
Your retirement fund will be harmed if you withdraw funds early, especially since you won’t be able to regain the contribution room you’ve lost.
Remember, however, that withdrawing several little sums over a short time to avoid paying the high withholding tax has its own set of drawbacks.
However, your financial institution may deduct the amount of withholding tax that applies to the whole amount.
For instance, if you intend to withdraw $20,000 but split it into four monthly withdrawals of $5000 to avoid the 20% tax rate. If your financial institution notices the pattern, you may still be subject to the 20% withholding rate on your last withdrawal.
Withdrawals are generally not encouraged, and you should consider choices before withdrawing from your RRSP.
What is Withholding Tax RRSP?
Withholding tax RRSP refers to the tax implication of withdrawing funds from your RRSP.
A withdrawal from your RRSP is usually considered income and subject to income tax by your financial institution.
However, your withdrawal rate depends on your residence and the amount you withdraw. Canadian residents pay the following rates:
- $5,000 = 10% (5% in Quebec)
- $5,000 – $15,000 = 20% (10% in Quebec)
- Over $15,000 = 30% (15% in Quebec)
On the other hand, 25% is the RRSP withdrawal tax rate for non-residents of Canada. Learn more here.
Note: There is also a provincial tax withholding for Quebec residents. Contact your financial institution or Revenu Québec for more information.
It is possible that the amount of tax withheld may not always match the amount you owe.
You may have to pay additional tax on the withdrawal if you include it in your Income Tax and Benefit Return for the year.
Because of this, withdrawing money from an RRSP is not generally recommended unless it is the last option.
Nevertheless, as long as your RRSP is not locked in, you can still withdraw funds at any time.
The withdrawal, however, is subject to withholding tax, which must be reported as income on your tax returns.
How Much is the RRSP Withholding Tax Rate?
Withholding tax rate depends on your residence and the amount you withdraw. The following are the withholding tax rate for different RRSP withdrawals:
- $5,000 = 10% (5% in Quebec)
- $5,000 – $15,000 = 20% (10% in Quebec)
- Over $15,000 = 30% (15% in Quebec)
On the other hand, 25% is the RRSP withdrawal tax rate for non-residents of Canada. Learn more here.
Note: There is also a provincial tax withholding for Quebec residents. Contact your financial institution or Revenu Québec for more information.
Additional Costs of Withdrawing Your RRSP Before Maturity
When you withdraw money, it counts as income, so you will need to declare it when you file your tax returns for that year.
However, you will have to pay more if you are in a higher tax bracket after the withdrawal. Because the withdrawal tax is unlikely to cover the full amount of income tax you will owe.
For this reason, you shouldn’t withdraw funds prematurely from an RRSP before you have exhausted all other alternatives.
Upon withdrawing from your RRSP, you will receive a T4-RRSP from your financial institution. The T4-RRSP shows how much tax was withheld and how much was withdrawn.
The amount withdrawn must be reported on your T1 General Income Tax Return in the year it was withdrawn.
On the Canadian Revenue Agency (CRA) website, you can find the current year’s income tax rates.
It’s also important to remember that you do not get your contribution room back.
The Canada Revenue Agency will only allow you to include the withdrawal amount if the withdrawal cannot be added back to the existing contribution room.
Therefore, you will reduce the amount of money that benefits from compounding in your account.
When Can I Withdraw from My RRSP?
Once your funds are not in a locked-in plan, you can make an RRSP withdrawal at any time. Remember, withdrawal from your RRSP is subject to withholding tax and must be reported as income when filing tax.
However, you can withdraw funds from your RRSP tax-free through the following:
- Home Buyers’ Plan (HBP) – for your first home
- Lifelong Learning Plan (LLP) – for funding education
You will not be taxed or report any withdrawal under the above grounds once you pay back the withdrawn amount at the appropriate time.
Mandatory RRSP Withdrawals at Maturity
You’re expected to mandatorily withdraw your RRSP funds on the last day of the year you reach 71. However, you have three options for withdrawing your RRSP funds.
1. Converting Your RRSP to RRIF
If you’re looking for a steady retirement cash flow, you can convert your RRSP to Registered Retirement Income Fund (RRIF) when it matures.
That said, you’re expected to make a minimum withdrawal each year from your RRIF. While you’re not taxed from these withdrawals, you must report them as income when filing tax.
However, you will be taxed when you exceed the annual RRIF withdrawal limit.
2. Lump Sum Withdrawal
You can withdraw all your RRSP funds when they reach maturity. However, this is subject to withholding tax.
Accordingly, you must report the withdrawn amount as income when filing your annual tax.
3 Convert Your RRSP an Annuity
If you’re looking to avoid withholding tax, consider converting your RRSP to an annuity. This way, you will get guaranteed income for a particular term or lifetime.
While you’re not taxed on the amount you used to purchase an annuity, you may be taxed on your annuity income.
How to Avoid Withholding Tax When Withdrawing RRSP Funds
If possible, you should avoid taking money out of your RRSP before retirement. You should not access your RRSP unless you are in extreme financial problems and have no other option.
Your financial institution will deduct withholding tax automatically when you withdraw from your RRSP before retirement.
Nevertheless, a small withdrawal of $5,000 or less may reduce your withholding tax liability.
But, if you withdraw cash under the Lifelong Learning Plan (LLP) or Home Buyers’ Plan (HBP), you can avoid RRSP taxes.
1. Home Buyers’ Plan (HBP)
The Home Buyers’ Plan lets you take up to $35,000 from your RRSP to put towards a house down payment.
As a result, if you plan to purchase a home with your partner, each of you can withdraw $35,000 from your RRSP, amounting to $70,000.
Repayment begins the second year after you withdraw the funds, and you have 15 years to pay back the funds.
The CRA will send you an annual statement every year revealing your HBP balance owing, your payment history, and the minimum payment amount.
However, you must prove that you are a first-time homebuyer to participate in this program.
2. Lifelong Learning Plan (LLP)
Participants in the Lifelong Learning Plan may withdraw up to $10,000 tax-free every calendar year from an RRSP to a maximum combined amount of $20,000 tax-free.
As long as your withdrawal doesn’t exceed $20,000, you can spread out the withdrawals over four years instead of withdrawing the entire amount at once.
LLP withdrawals must be repaid over ten years, beginning in the fifth year of withdrawals.
You will receive an annual LLP notice from the CRA that describes the amount of your next LLP payment and your LLP balance,
However, LLP repayments must still be designated on Schedule 7 each year when filing your income tax return.
RRSP Tax Waiver or Cancellation
In some cases, the Canada Revenue Agency can waive or cancel all or part of your taxes.
Nevertheless, the CRA will decide if it is appropriate after reviewing all factors, including:
- There was a reasonable error that led to the tax
- If the same transaction generated another income tax under the Income Tax Act and the tax arising from the transaction.
- Whether a person’s registered plan has been used to make payments
However, a waiver only applies to taxes paid according to the anti-avoidance rules and not to taxes paid under any other provision of the Income Tax Act.
Therefore, you must include a letter explaining why the tax liability arose and why the tax should be cancelled or waived in whole or in part.
If you live in the following areas:
- Prince Edward Island
- Ontario
- Yukon
- Nunavut
- Newfoundland and Labrador
- Northwest Territories
- Montreal
- Sherbrooke
- Longueuil
- Quebec City
- Laval
- Gatineau
Send your request to the following addresses:
Canada Revenue Agency
Sudbury Tax Centre
Pension Workflow Team
Post Office Box 20000, Station A
Sudbury ON P3A 5C1
Those who live in:
- Manitoba
- New Brunswick
- Alberta
- British Columbia
- Saskatchewan
- Nova Scotia
Can send their request to:
Canada Revenue Agency
Winnipeg Tax Centre
Pension Workflow Team
Post Office Box 14000, Station Main
Winnipeg MB R3C 3M2
Spousal RRSP Withdrawals
Contributing to a spousal RRSP is key to getting a tax break now and later.
The following are the two major rules of Spousal RRSP withdrawals after contributing.
- Your spouse is entitled to the money. Thus, the spousal RRSP withdrawal is taxed based on their tax income.
- You must claim any withdrawal your spouse makes within three years of your contribution as your taxable income.
Overall, ensure you avoid early spousal withdrawals to escape tax penalties.
Conclusion
Sometimes making tough financial decisions can be difficult. But it doesn’t have to be so.
With an RRSP, your money can grow on its own through investments with no tax on the growth.
You don’t have to pay income tax when you contribute to your RRSP or when contributions are made by someone else for you.
However, when you make withdrawals from your RRSP before retirement, they are fully taxable in the year of withdrawal.
Thankfully, there are solutions to help you reduce or avoid your withdrawal taxes.
Hopefully, now you know how to reduce or avoid your RRSP withdrawal taxes.
FAQs on Withholding Tax RRSP
Is there a withholding tax on RRSP?
Yes, you are subject to withholding tax on RRSP withdrawals, but the rate depends on where you live and how much you withdraw.
How much tax do you pay on RRSP withdrawals?
The withholding tax on RRSP depends on the amount you withdraw and your location. The following are the rates for Canadians:
- $5,000 = 10% (5% in Quebec)
- $5,000 – $15,000 = 20% (10% in Quebec)
- Over $15,000 = 30% (15% in Quebec)
On the other hand, 25% is the RRSP withdrawal tax rate for non-residents of Canada.
How is RRSP income taxed?
If funds remain in your RRSP, income from the plan is usually tax-free; payments received from the plan are generally subject to tax.
The RRSP income withdrawal is taxed based on your location and the amount you withdraw.
What do I do with my RRSP when I retire?
There are three things you can do with your RRSP when you retire: 1) convert your RRSP to RRIF; 2) withdraw all your RRSP funds as cash; 3) convert your RRSP to an annuity.
Can I transfer RRSP to TFSA without penalty?
There are tax penalties for transferring RRSP to TFSA. The tax penalties vary by the amount you want to transfer.
What’s better TFSA or RRSP?
A TFSA offers more flexibility and better tax benefits than an RRSP, but its contribution room is lower. You can set aside more in an RRSP, but withdrawals are subject to stricter rules.
However, you can combine your RRSP and TFSA accounts to take advantage of both accounts’ benefits and address their shortcomings simultaneously.
