Understanding RRSP Withholding Tax After Contribution and Withdrawal in the Same Year

When you make contributions to your Registered Retirement Savings Plan (RRSP) and subsequently withdraw the same amount during the same tax year, it can get a bit tricky when it comes to withholding tax. This article aims to clarify the process and explain how you can recover any withheld tax.

How Withholding Tax Works

When you contribute to your RRSP, the tax department withholds a certain amount of tax based on a fixed rate. This is usually a percentage of the amount you contributed. Similarly, when you withdraw funds from your RRSP, withholding tax is also deducted based on a specific rate for amounts withdrawn up to a certain threshold.

Recovery of Withholding Tax

The actual amount that you would recover when filing your taxes the following year will depend on your marginal tax rate and the amount of the withdrawal. Here is a detailed breakdown of the process:

Your Year-End Tax Calculation

At the end of the year, your contributions will be added to your taxable income, and the corresponding tax deduction will lower your total tax bill. The withholding tax you paid when withdrawing funds will be credited towards your final tax bill. However, the amount of the withholding tax is fixed, and it does not completely offset the tax due on the withdrawal.

Example of Withholding Tax

If you contributed $8,000 to your RRSP and your marginal tax rate is 45%, the deduction for your deposit would be $3,600 (45% of $8,000).

If you withdraw the same $8,000 in the same year, the withholding tax would be calculated as follows:

10% on the first $5,000 (which is $500) 20% on the remaining $3,000 (which is $600) Total withholding tax: $1,100 (Note: This calculation may vary in Quebec and other provinces)

After the withholding tax is deducted, you would receive $6,900 ($8,000 - $1,100).

At year-end, the $8,000 withdrawn is added to your taxable income. The $3,600 deduction is applied, reducing your liability. However, the $1,100 withholding tax you paid is credited towards your final tax bill.

Result of the Calculation

This means you will owe an additional $3,600 (45% of $8,000) due to the withdrawal, but you have a credit of $1,100 for the withholding tax already paid. Your net liability will depend on your overall tax situation.

Note: There might be small variations in the final amounts due to other tax complications or additional deductions that may apply.

Additional Information on Withholding Tax Tiers

For clarity, here are the withholding tax tiers for RRSP withdrawals:

Withdrawals up to $5,000 are taxed at 10% in most provinces, 5% in Quebec. Withdrawals between $5,001 and $15,000 are taxed at 20% in most provinces, 10% in Quebec. Withdrawals of $15,001 or more are taxed at 30% in most provinces, 15% in Quebec.

Understanding these tiers can help you plan your RRSP withdrawals more effectively and minimize any potential tax liabilities.