Whenever you make a withdrawal from your RRSP there will be a withholding tax applied. Actually, it would be better to say that financial institutions "WITHHOLD tax" and remits it to the government on your behalf. The way the terminology is used makes it sound like a special type of tax – but it isn’t: it’s income tax!
The reason your financial institution will withhold tax and remit it to the government is because when you take money out of your RRSP it is considered taxable income – just like you earned it in salary for example. If you remember, the tax reduction you get when you make an RRSP contribution is generated because the government lets you deduct it from your earned income for that year. Well, when it comes out again it then becomes taxable. Just as a Mountie always gets his man – the CRA always get their taxes!
Your financial institution is required to withhold the following amount of tax on a withdrawal from your RRSP:
Amount of Withdrawal Amount of Withholding Tax
$0 – $5,000 10%
$5,001 – $15,000 20%
$15,001 and above 30%
(The percent withheld is half of the above listed rates if you live in Quebec.)
So if you requested that $5,000 from your RRSP be withdrawn and transferred to your chequing account, only $4,500 would show up since $500 (10% of $5,000) was withheld and remitted to the government on your behalf. (If you needed $5,000 to spend, make sure to tell your financial institution to transfer $5,000 NET as opposed to GROSS.)
Think of the tax withheld on an RRSP withdrawal as being like the tax withheld on your pay cheque. The reason they do this is so that you won’t have such a nasty surprise when it comes time to file your taxes – i.e. owe them lots of money instead of getting a refund. You’ll note that the amount of tax withheld may not correspond to your marginal tax bracket – so you may still end up owing money nonetheless, especially if you are in a higher tax bracket than the withholding tax bracket:
Let’s say that Sharon earns $150,000 from her job as the CEO of a company and is in the 46.41% marginal tax bracket. If she had to make a $5,000 withdrawal from her RRSP she would have to include $5,000 on her income for the year – on top of her $150,000 salary. While she was paying tax on $150,000 through payroll-deducted taxes – she will have to pony up at the end of the year because her actual earned income is $155,000. Applying a 46.41% marginal tax rate on $5,000 shows that she would owe $2,320.50 in income tax on this extra $5,000. But her financial institution only withheld $500. She will therefore have tax owing after filing her income taxes of $1,820.50 ($2,320.50 tax owing – $500 already withheld).
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