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