One of the benefits of RRSPs is the flexibility you have to withdraw some of the money before retirement. However, even though you can withdraw money from your RRSP prior to retirement, it doesn’t mean that you should. The action comes with a cost. That cost is a withholding tax.

Withholding tax is the amount that the bank is required to submit to the CRA on your behalf. When you withdraw money from your RRSP, you are required to pay taxes, and the bank takes a portion of your withdrawal and sends it on.

How Much Withholding Tax Will You Pay?

Since withdrawn RRSPs are considered income in that year, the withholding tax is similar to your employer withholding a portion of your income to submit for your tax obligations.

There are three levels of percentage withheld, depending on the amount of your withdrawal:

• Up to $5,000 will have a 10% (5% in Quebec) withholding tax
• $5,001 to $15,000 will have a 20% (10% in Quebec) withholding tax
• $15,001 or more will have a 30% (15% in Quebec) withholding tax

Non-residents of Canada pay a withholding tax of 25%, except in places where that amount is reduced by treaty. Living outside of Canada, then, could cost you if you decide to withdraw your RRSPs.

Obviously there is a benefit to keeping your individual withdrawls to $5,000 or less. You will pay less in withholding tax. However, if you need more money, it may not matter, and you will have to pay the higher amount in tax.

While you might think it’s beneficial to have access to more of your money throughout the year, thanks to your RRSP, keep in mind that this is not your tax rate. You will still owe your regular income taxes on top of the withholding tax come April 30.

If your marginal tax rate for the year is 20%-50%, you could end up owing the government quite a bit more come tax time than the 10% you have paid so far. If you are withdrawing RRSPs for retirement, or any other time you are in need of income, you should know your marginal tax rate so that you will be prepared for the amount of tax you will still need to pay. TaxTips has personal income tax rate tables to show you this percentage by province, by income range.

Other Costs of Withdrawing RRSPs

The cost of your withholding tax, and the cost of taxes paid on your withdrawal as income, aren’t the only costs associated with withdrawing RRSPs. You also have to consider the opportunity cost.

Once you withdraw that money from your account, it is no longer working on your behalf. You no longer have that capital in your account building your wealth. You can’t get that lost time back, and the interest you would have earned, even if you replace the capital later.

Before you decide to withdraw your RRSPs, make sure that you consider all of your options. Consult with a knowledgeable financial professional who can help you figure out the best way to go about making your withdrawals, and who can help you plan for your tax payments.

Withholding Tax on RRSP Withdrawals: What You Need to Know appeared first on Canadian Finance Blog.