Tuesday, March 22, 2011

RRSP Withholding Tax

A very important thing to remember is that contributions to Registered Retirement Savings Plans (RRSPs) are tax deductible.  That means that you in the year you contributed to your RRSP, you were able to claim less income, thus reducing the taxes you paid.  This is a major incentive by the government to help people save money by helping them reduce personal income taxes at the same time.

The general plan is that you will keep that money growing in your RRSP, tax deferred, until you start making withdrawals in retirement.  Notice that RRSP investments and growth are tax deferred, not tax free, meaning you will have to pay taxes on the money as you withdraw it from your RRSP.

The Question - So how much tax do you pay on RRSP withdrawals?

There are 2 parts to the answer for this question.   The first part is the withholding tax, or the amount that the Federal Government requires financial institutions to withhold when you take your money out.  In all provinces, except Quebec, the schedule is as follows:

$ Amount                    Withholding tax                Example
The first $5,000                10% is withheld     $5,000 - 10% ($500) = $4,500 cash
$5,001 to $15,000             20%                     $10,000 - 20% ($2,000) = $8,000 cash
$15,001 and up                 30%                     $20,000 - 30% ($6,000) = $14,000 cash

The second part of the answer is your personal income tax rate.  Because you reduced your taxable income by the amount of your RRSP contribution in the year you made the contribution, your RRSP withdrawal will be counted as be taxable income in the year you withdraw the money.  If you make a withdrawal before retirement, it is likely that your income tax level will be higher than if you withdraw during retirement, thus you will pay more tax.

For example, in Alberta, if you are making $50,000/year, any additional regular personal income will be marginally taxed (federally and provincially) at about 32%.  This means that a RRSP withdrawal will be taxed at 32%.  So if your withdrawal is $5,000, you will pay about (32% of $5,000) $1,600 in taxes.  You already had a 10% withholding tax applied, so at year end you will pay the following: $1,600 (taxes) less $500 (withholding tax already paid) = $1,100 still owing.

My recommendation is to be very careful about withdrawing RRSPs without a long term plan.  Even in retirement the taxes on withdrawals from registered plans can be quite onerous, but I will speak to that another day.  Jerry

Wednesday, March 9, 2011

Lotto Wins for Retirement?

Macleans has an article out this week that speaks about how lotteries are now the retirement plan of choice for 32% of Canadians between 45 and 64 years old.  This not only a surprisingly high percentage, but it almost matches the 34% who said they actually have retirement plans and investments to go with the plans.

The chances of winning Lotto Max are about 1 in 85 million, or about 0.0000012%.  Not great odds.  Yet, the closer people get to retirement, the more concerned they are that they haven't saved enough and are turning to lotteries as a hopeful "quick, cheap fix" to get the retirement savings they will need.

I'm not trying to condemn lotteries, but I want to emphasize that planning on winning the lottery to fund your retirement is not a plan at all.  It's a gamble with your retirement's financial security, and the odds are not in your favour.

What is the best way to retire financially secure?  Start early, create and periodically update a plan, invest regularly, diversify your investments to reduce risk, and live on less than you make.

When people don't feel financially secure, they start to do things that don't always make sense, reacting out of fear rather than following a logically laid out plan.  These over-reactions often fall into 2 categories:

Thursday, March 3, 2011

GIS and Allowance Facts

Wow, since posting the article on Old Age Security (OAS) and Canadian Pension Plan 9CPP) Myths and Facts a few weeks ago, we have gotten a few phone calls questioning the accuracy of the article.  In each case where someone thought the government had clawed back their OAS, it turns out they had actually clawed back the Guaranteed Income Supplement (GIS) or Allowance.  The information in the article stands true, but I am writing this one about GIS and Allowance to add information about the GIS and Allowance program.

Guaranteed Income Supplement Facts
  • The Guaranteed Income Supplement(GIS) is provided to OAS pensioners with little or no other income.
  • You must be 65 years old or older to receive OAS & GIS.
  • GIS must be applied for.
  • GIS is not taxable income.
  • Once income is over the maximum amount to receive the maximum benefit, GIS is clawed back at the rate of $0.50 for every $1 over the threshold until the maximum is met, as indicated below.