How does withholding tax on RRSPs work?

With the Registered Retirement Savings Plan’s (RRSP) long-term growth potential and tax benefits, it has become the favoured tool for many Canadians’ retirement strategy. To maximize these benefits, knowing the RRSP’s many ins and outs is important, particularly when it comes to its withholding tax.

So, what is the RRSP withholding tax? How does it work? Wealth Professional offers some answers. Share this article with your clients who would like to know more about RRSPs and the taxes that come with it.

What is the RRSP Withholding Tax Rate?

Depending on the type you have, you can withdraw money from your RRSP anytime. However, remember that doing so can incur penalties and/or withholding taxes, especially if withdrawals are done well before retirement.

The withholding tax rate can vary, depending on your location and the amounts you withdraw. In general, the financial institution that handles your RRSP applies the withholding tax on your withdrawals.

The withholding tax rates for residents of Canada are as follows:

While it seems that the withholding tax rate in Québec is lower, there are applicable provincial taxes on RRSP withdrawals. In 2023, there is a provincial income tax of 14% (15% if before 2023), tacked onto RRSP withdrawals, including the above listed withholding tax rates.

If you are a resident of Québec or would like to know more about their withholding tax, consult a financial institution there or refer to Revenu Quebéc.

If you are a non-resident of Canada by the time you make an RRSP/RRIF withdrawal, you will have to pay a 25% non-resident tax. This tax is applied at this rate, regardless of the amount of money withdrawn from your RRSP. However, this rate can be reduced if the country you move to has a tax treaty with Canada.

Does the RRSP get taxed twice?

Yes, it does. The first taxation is via withholding taxes, which are deducted by the financial institution that handles the RRSP. As seen in the table above, RRSP withholding taxes are set at 10%, 20%, and 30%, depending on the amounts withdrawn for Canadians (rates are different for residents of Québec).

Later on, when the income tax returns are filed, the amount withdrawn or RRSP income is considered part of taxable income and charged a second time with the appropriate taxes.

What happens to my RRSP and its taxes if I leave Canada?

The tax implications for doing this can get a bit complicated. For one, this may result in double taxation when you withdraw funds. You can be taxed in Canada for withholding tax, then compelled to pay income taxes in both Canada and in the country you moved or emigrated to. It might be a good idea to check first which countries have tax treaties with Canada and think about the tax implications.

Contrary to popular belief, you can also choose not to withdraw or transfer your Canadian RRSP (or even RRIF) should you decide to leave the country. With this option, you can still keep your RRSP or RRIF intact and allow it to grow at the same tax-deferred status for Canadian tax purposes.

But remember, the country you consider moving to may not offer the same tax deferral and tax the growth on your RRSP/RRIF as income. You will also have to file a part-year tax return if you decide to leave Canada in the middle of a tax year. The Royal Bank of Canada provides more details on the tax implications of leaving Canada.

Withholding Tax Anti-Avoidance Rules

As of March 2011, additional anti-avoidance rules for the withholding tax were implemented. This covers:  

Taxes on non-qualified investments

There is a 50% tax imposed on the annuitant of an RRSP/RRIF if these acquire a non-qualified investment, or if an existing investment turns into a non-qualified investment. In some cases, the tax may be refundable.

The annuitant is also accountable for 100% of the advantage tax on non-qualified investment income if this is not promptly withdrawn. In this case, the annuitant must file an Individual Return for Certain Taxes for RRSPs or RRIFs (Form RC339) should they have outstanding taxes for that year.

Financial Institutions’ responsibilities with respect to the non-qualified investment rules

Financial institutions must inform the Canada Revenue Agency (CRA) and the annuitant when an RRSP or RRIF trust starts or ceases to have a non-qualified investment in a year. This happens if the investment becomes non-qualified, or the non-qualified investment is sold.

Taxes on prohibited investments

A prohibited investment may be composed of:

• a debt of the annuitant
• a debt, share, or interest in a corporation, trust or partnership where the annuitant has a significant interest (10% or higher)
• a debt, share, or interest in a corporation, trust or partnership with which the annuitant does not deal at arm's length

The rules on withholding tax for prohibited investments impose a 50% tax if the annuitant acquires a prohibited investment or if an existing one becomes prohibited.

This tax may be refundable in some cases. The annuitant also becomes accountable for the 100% advantage tax on income earned and realized capital gains on these investments. Annuitants with prohibited investments must likewise file RC339.  

Financial institutions’ responsibilities with respect to prohibited investment rules
While RRSP issuers and RRIF carriers have no obligation under the Income Tax Act to identify prohibited investments, financial institutions are presumed to not knowingly facilitate the holding of a prohibited investment, considering there are serious tax consequences for the annuitant. Compliance with prohibited investment rules is the annuitant’s responsibility.

Taxes on Advantages

An advantage is defined as any benefit, loan or debt that depends on the existence of the RRSP or RRIF. This is apart from distributions, administrative or investment services in connection with the RRSP or RRIF, loans on arm's length terms, and payments or allocations (like bonus interest) to the RRSP or RRIF by the issuer or carrier.

Other forms of advantage include any benefit that translates to an increase in the total Fair Market Value (FMV) of the property held in connection with the RRSP or RRIF.

Financial institutions’ responsibilities with respect to the advantage rules
Financial institutions typically have no obligation under the Act to identify investments or transactions that can make the annuitant liable for the advantage tax. However, it is presumed that financial institutions would not knowingly hold or participate in such investments or transactions, considering that the annuitant may face serious tax consequences.

Transfers of non-qualified or prohibited investments between financial institutions

When this happens, the transferring and receiving institutions should submit Form T2033 to the CRA to report the transfer of said investments. However, financial institutions are again not presumed by the CRA to knowingly accept transfers of non-qualified or prohibited investments from annuitants or other financial institutions.

These new rules can allow for partial or total refunds or exemptions of these taxes in certain cases. For more information, taxpayers should visit the CRA website for updates.

Avoiding Taxes when making RRSP Withdrawals

Why is knowing how to avoid taxes when making RRSP withdrawals important? If you’re like many Canadians, you probably already made withdrawals or are considering this at some point. 

Even though the RRSP is a popular retirement savings vehicle, it is widely used as an alternative savings account, according to a survey.

Should you decide to make an early withdrawal, there are ways to avoid paying the withholding taxes on the amount you withdraw:

The Home Buyers’ Plan

Also called the HBP, the Home Buyers’ Plan lets RRSP account holders withdraw up to $35,000 for buying or building their first home, tax-free.

If there’s a spousal RRSP, spouses or common-law partners can combine this benefit for a total withdrawal of $70,000. The only downside to the HBP is that the money has to be repaid within 15 years, with the payments starting two years after the withdrawal was made.

The Lifelong Learning Plan

Another feature of RRSPs is the Lifelong Learning Plan or LLP. In this plan, you can withdraw up to $10,000 in a calendar year to pay for full-time education or training for you or your spouse/common-law partner.

RRSP account holders can use the LLP if they meet the conditions every year, as set by the CRA.

The LLP cannot be used to fund your child’s education and the total amount withdrawn cannot exceed $20,000. Amounts withdrawn for the LLP must be repaid to your RRSP within 10 years, with an accompanying interest rate pegged at 10% per year.    

Consequences of Withdrawing from Your RRSP Early

While it’s no one’s place to say what you or anyone else should do with their RRSP account, be forewarned: making withdrawals that aren’t for the HBP or LLP can have consequences. So how bad can it be if you withdraw from your RRSP early?

1. You pay withholding tax – Canadian residents have their RRSP withdrawals subject to withholding taxes. These are deducted by the financial institution handling the account. Those who live in Quebec are subject to different taxes, along with a 14% to 15% provincial tax, depending on when the RRSP withdrawal was made.
2. You pay income tax – Apart from the withholding tax, early RRSP withdrawals become part of taxable income. These are filed in the income tax returns for the calendar year.
3. You might have to pay at a higher tax bracket – If you didn’t make computations before making a withdrawal from your RRSP, this might significantly increase your income for the year. As a result of an early or ill-timed RRSP withdrawal, this can place your income in a higher tax bracket, obligating you to pay higher tax for that year.
4. You cannot recover contribution room – Should you choose to withdraw money early from an RRSP, the contribution room you used to make your contribution in the first place is permanently lost.
5. Your savings lose out on potential growth – Since RRSP contributions can earn compound interest over time, you can lose significant growth. Remember that even a small withdrawal you make now can have a huge impact on your savings down the line.

RRSP Withdrawal Strategies to Minimize Taxes

While you can avoid paying taxes on early RRSP withdrawals by using the Home Buyers’ Plan or Lifelong Learning Plan, there are other ways to minimize taxes on your RRSP withdrawals. You can:

1. Convert your RRSP to an RRIF

It’s possible to reduce or mitigate taxes on RRSP withdrawals by converting it to a Registered Retirement Income Fund (RRIF). This route can be done in three ways:

1. Allowing it to mature (meaning you reach age 71) then converting it into an RRIF.
2. Converting your entire RRSP to an RRIF at age 55, but you’ll have to make small yearly withdrawals at a certain minimum from then on.
3. Making an early conversion of only a portion of the RRSP to an RRIF, which might be the most practical option.

Any amounts converted to the RRIF are tax-deferred; the appropriate income taxes will apply to the withdrawals.

2. Move the funds to a TFSA

Another way is to transfer a portion of your retirement savings into a tax-free savings account (TFSA). Doing this allows for unlimited withdrawals without incurring tax penalties. Any dividends, interest, or capital gains earned on the investments in a TFSA are also tax-free.

To find out more, here’s an article on strategies to minimize taxes on RRSP withdrawals.

Understanding the T4RSP Form

The T4RSP shows the RRSP account holder how much money was withdrawn or received from the RRSP and how much tax was deducted.

A T4RSP can indicate the amount withdrawn under the Home Buyers' Plan, or the amounts transferred from an RRSP to a spouse or common-law partner due to a court order or written agreement.

The T4RSP form likewise shows withdrawals from an RRIF, as well as a Life Income Fund, Locked-In Retirement Income Fund, and a Prescribed Retirement Income Fund.

Here’s a video that sums up what you can and should do with your RRSP:

Knowing how withholding taxes work on your RRSP can help you maximize its benefits. The best you can do is wait for the RRSP to mature and avoid making any unnecessary withdrawals to avoid taxes.

As for using features like the HBP or LLP, weigh your options first and consider if the tradeoff of having a smaller retirement fund is worth it. Remember that you can also consult a financial advisor to know the best option for your circumstances.  

Now that you have a better picture of how to avoid or reduce taxes on your RRSP withdrawals, will you take some money out? What will you use the withdrawals for? Tell us in the comments!