RRSP Explained Part 2 | Withdrawals & Withholding Taxes | Canadian Tax Guide Chapter 4

hey guys it's Adrian here the Canadian in a T-shirt and today i'll continue my breakdown of what is an RRSP and how to invest in your rrsp to minimize your tax bill and maximize your long-term growth this is part two of my RRSP series in this video i'll go over the rules for withdrawing from your RRSP either before or during retirement and i'll go over how withholding taxes work make sure you check out part one of my RRSP series first so click the pop-up at the top right check out part one first and then come back to this video in part one i went over the benefits of an rrsp who is eligible for an rrsp the contribution limits and the rules to follow regarding tax deductions this is the fourth chapter of my canadian tax guide so i'll be assuming you have a basic understanding of taxable income tax brackets and deductions if you need a refresher on how canadian taxes work click the pop-up at the top right to check out my previous videos on canadian taxes i'll also be comparing the rrsp to the tfsa so make sure you check out my tfsa video as well picking up where we left off in part one the rrsp is the registered retirement savings plan and it's a tax sheltered account designed to help canadians plan for their retirement so it's focused on long-term investing as a quick recap the SKIP AHEAD: -What is the RRSP? 0:56 - covers two main benefits to canadians one it allows you to defer your taxes to a future year ideally when you retire so when you put money into your rrsp you can reduce the taxes you pay this year and delay those taxes by 30 years until you retire at that point in retirement you should have a smaller income so you should be in a smaller tax bracket and so you'll pay less in taxes than you would during your working years in part one i focused on reducing your taxes using rrsp deductions in this video i'll be focusing on how you actually get taxed when you finally do withdraw that money from your rrsp ideally when you retire the second benefit of the rsp is that it allows your investments to grow tax-free the rrsp is tax sheltered so any income you earn inside your rrsp will not be taxed so any dividends interest or capital gains you make will be tax free and so your investments will grow much faster inside an rsp than they would in a non-registered account let's focus on withdrawing from your rrsp remember contributing to an rrsp is a deal you make with the government you're saying i don't want to pay a large tax amount right now i'll delay these taxes by 30 years and pay a much smaller tax amount when i retire during these 30 years my investments are growing tax-free but when i finally need this money and i decide to take that money out of my rrsp then i pay taxes on this withdrawal amount and this gets taxed as regular income contrary to popular belief there's no explicit penalty for withdrawing your money out of your rrsp before retirement you shouldn't do it because you'll be losing out on the long term investment and tax saving benefits of an rrsp which i'll get to but strictly speaking you can withdraw out of your rsp whenever you want you'll just have to pay taxes on that amount and those taxes depend on your income whenever you make a withdrawal out of your rrsp that amount you take out gets added to your taxable income for the year if you have a high salary you'll be in a high tax bracket and so if you withdraw out of your rrsp you'll pay a lot in taxes whereas if you made the same withdrawal out of your rrsp during retirement your income will be much smaller and so you'll pay much less taxes on that withdrawal let's go over a simple example i'll be using the tax brackets for 2020 and for simplicity let's not look at provincial taxes i'll only be looking at the federal taxes let's say i have a large income of 100,000 per year i've covered how tax brackets work in my previous tax videos so i'll go over this very quickly i totally fill up the first tax bracket at fifteen percent then i completely fill up the second tax bracket at twenty point five percent and now my remaining income of two thousand nine hundred and thirty one dollars goes into my third tax bracket with a 26 marginal tax rate so in total i pay almost 18,000 in federal taxes provincial taxes would add even more now let's say i do something stupid let's say i want to buy a boat which costs twenty thousand dollars there's nothing wrong with buying a boat if i could pull that cash out of my savings account or even out of my tfsa if i had to but in this example i'll make a stupid decision and i'll withdraw that twenty thousand dollars out of my rrsp to buy this boat i'm allowed to do this i won't be slapped with any additional penalties for withdrawing before retirement but i will be taxed heavily because of my large income so now this 20 000 withdrawal gets added onto my taxable income so when i file taxes i'll be taxed as if i made a hundred and twenty thousand dollars so let's go through it once again i maxed out the first tax bracket and i maxed out the second tax bracket but now i have an extra twenty thousand dollars that will be taxed in my highest tax bracket with a rate of 26 so in total i will pay over 23 000 in taxes i wanted to buy a boat and by withdrawing 20 000 out of my rsp i am charged 26 out of this 20 000 so i lose five thousand two hundred dollars all because i withdrew from my rsp while i was in a high tax bracket if my salary was even higher or if i withdrew a larger amount that withdrawal could have bumped me into an even higher tax bracket costing me even more in taxes let's see what happens if i make the same withdrawal during retirement when i have a low income let's say i have a pension which pays out a small amount of twenty thousand dollars per year in this case my entire income fits in the first tax bracket so i only pay 15 of this so we pay 3 000 in federal taxes in fact for such a low income after tax credits and tax deductions you'll barely be paying any taxes at all now let's see what happens when i withdraw 20 000 out of my rrsp just as before this twenty thousand dollar rrsp withdrawal adds on to my taxable income so when i file my taxes i'll be taxed as if i made forty thousand dollars a year luckily this still fits in the lowest tax bracket so i will only pay fifteen percent on this forty thousand dollars so in total i pay six thousand dollars in taxes since i'm in a low tax bracket during retirement i only pay three thousand dollars out of this twenty thousand dollar withdrawal again these examples only contain federal taxes you'll also have to pay provincial taxes on these withdrawals let's look at the total taxes we would pay on these rrsp withdrawals these amounts will come in handy in a few minutes when i bring up withholding taxes let's say that in both examples i live in ontario so if i'm retired in ontario with a salary of twenty thousand dollars i'll be in the first tax bracket with a marginal tax rate of twenty point zero five percent that includes both federal and provincial taxes and if i'm working with a salary of a hundred thousand dollars i'll be in a high tax bracket with a marginal tax rate of 43.41 when i withdraw 20 000 for my rsp i will pay the marginal tax rate on this 20 000 amount so when i'm retired i only pay 4 000 and 10 in taxes on this withdrawal in fact i would pay even less when i factor in tax credits when i file my tax return now for the high income earner i'm paying 43 in taxes on this withdrawal so i will pay 8 682 in taxes from my 20 000 that's more than double the taxes i would pay in retirement clearly you lose a lot in taxes if you withdraw from your rsp during your high income years but what if your income drops before retirement what if you get laid off or you decide to start your own business and for a year or two you have very low or even no income should you withdraw from your rrsp in that case you'll be in a low tax bracket just like you would during retirement so it's true you'll pay very little in taxes on this rrsp withdrawal you won't be slapped with any additional penalties for withdrawing early you'll just pay the regular tax amount on that withdrawal but you still shouldn't withdraw from your rsp unless it's absolutely necessary and that's because when you withdraw money from your rsp you do not regain this contribution room that room is gone forever this is very different from the tfsa where if i withdraw 20 000 for my tfsa this year i would regain that contribution room next year but this doesn't work for rrsps as soon as you make a withdrawal from your rrsp that contribution room is gone forever you can never put that money back in so for the rest of your life you will lose that 20 000 of tax-free contribution room if you really need money take it out of your savings account or your non-registered investments or even out of your tfsa if it comes to it as soon as january 1st hits you'll be able to put that withdrawal amount back in your tfsa so you'll only lose a few months of tax sheltered growth but if you withdraw from your rrsp you lose a lifetime of tax shelter's growth which you never get back so don't withdraw from your rrsp unless absolutely necessary there are two exceptions to this the home buyers plan and the lifelong learning plan which i'll get to in part three in these examples i showed you the total amount of taxes you would pay on these rsp withdrawals but these taxes actually come in two stages first when you withdraw money from your rsp your bank or financial institution will immediately charge you a withholding tax so if you withdraw twenty thousand dollars to buy your boat you don't get this twenty thousand dollars in your hands you immediately pay a withholding tax up to thirty percent and you get what's left over then at the end of the year when you file your taxes you will either receive a tax refund if you pay too much in withholding taxes or you'll have to pay even more in taxes if there's a difference withholding taxes aren't a penalty they don't increase the total amount of taxes you pay it just forces you to pay some taxes up front and then pay the rest when you file your tax returns let's break down how withholding taxes work if you withdraw five thousand dollars or less from your rrsp you'll pay 10 in withholding taxes and you'll keep the rest if you withdraw between five thousand and fifteen thousand dollars you'll pay twenty percent up front and if you withdraw more than fifteen thousand dollars from your rsp you'll pay thirty percent right away in withholding taxes note that for quebec residents you'll have different tax rates so let's return to our example where we withdraw twenty thousand dollars from our rrsp this is the total amount of taxes you pay when you file your tax return but since we're withdrawing more than fifteen thousand dollars at once we will be charged an immediate thirty percent withholding tax on this twenty thousand dollars it doesn't matter what our income is in both cases we pay thirty percent or six thousand dollars up front in withholding taxes this is important we withdraw twenty thousand dollars from our rsp but the government immediately takes away six thousand dollars so we're only left with fourteen thousand dollars in our hands if i needed twenty thousand dollars to afford that boat i wouldn't have enough i would actually have to withdraw almost twenty nine thousand dollars from my rsp to end up with 20k in cash again please don't withdraw from your rrsp to buy a boat but the point is if you have a dollar amount that you need plan ahead and prepare for these withholding taxes okay so we received our 14 000 in cash and we can do whatever we want with it now what happens during tax season well in the case of retirement when we're at a low income we actually overpaid in taxes we paid six thousand dollars upfront and withholding taxes but since our income is low we actually only owed four thousand and ten dollars in taxes so when we file our taxes we'll get this difference back and we'll receive a tax refund of one thousand nine hundred and ninety dollars but in the case of the high income earner i paid six thousand dollars up front but that's not enough i still owe the government more so when i file my taxes i'll have to pay them the difference so i'll have to pay an additional 2 682 dollars in taxes to reach my total so even in retirement when you withdraw that money from your rsp be prepared to pay that withholding tax upfront most canadians in retirement convert their rsp into a RRIF a registered retirement income fund in fact once you reach the age of 71 you are required to convert your entire rrsp into a RRIF i'll talk about this more in a later video but a RRIF forces you to withdraw a minimum amount from your retirement fund every single year and pay taxes on these withdrawals by using a RRIF you can reduce or even eliminate the withholding taxes you would pay on these withdrawals so you don't have to worry about upfront taxes you only have to pay taxes during tax season i'll be making a whole video on rifts and i'll go over different strategies to reduce the total amount of taxes you pay during retirement and i'll go over key concepts like spousal income splitting and oas claw back so stay tuned for that video there is a lot to talk about with rrsps so i'm going to make a part 3 of this video where i will talk about the two special exceptions which allow you to withdraw money from your rrsp without paying any taxes and that's the home buyer's plan and the lifelong learning plan these two programs can help you fund the purchase of your first home or fund post-secondary education for you or your spouse but not for your kids these are very popular programs but there are some rules to consider and they're not always the best route to take so check out my upcoming video to learn more in part three i'll also talk about what kind of investments to hold in your rrsp to maximize your tax sheltered benefits i know a lot of you guys have been waiting for this information so i'll give you a super short summary right now i reserve my limited rsp room for high-yield us dividend stocks and u.s dividend etfs just make sure you hold these etfs in u.s dollars not canadian dollars by holding these u.s investments in your rrsp your dividends will grow tax-free and you won't be paying any taxes on capital gains plus you will avoid the 15 u.s withholding taxes that you would be paying on u.s dividends in your tfsa there's a lot to talk about with investing in your rsp so make sure you check out part three coming soon and of course if you'd like to get started with questrade which is my favorite online broker especially for us investments in my rrsp click the referral link in the box below and you'll get 50 in commission free trades when you sign up that basically means that your first 10 stock trades will be commission free that's 50 in savings plus i'll get a small referral bonus as well also i've been getting a lot of questions about questrade's rsp account the rsp and the rrsp are the same thing earlier this year Questrade decided to rename their rrsp account to the rsp account but nothing has changed in my video tutorial on how to buy us stocks with questrade you'll see the account name rrsp in my questrate but if you open up an account now it'll be called rsp don't worry it's the exact same thing it's just renamed so there you have it that's almost everything you need to know about rrsp withdrawals there's no direct penalty for withdrawing before retirement but you should still avoid doing so anytime you withdraw from your rrsp that money will be taxed as regular income but remember once you withdraw from your rrsp you never regain that contribution room so you will permanently lose the tax shelter benefits on that money also when you withdraw you will immediately be charged withholding tax and then when you file your taxes at the end of the year you will either receive a tax refund if you overpaid on those withholding taxes or you'll have to pay even more in taxes if you underpaid thanks for watching guys and be sure to like comment and subscribe if you found this video helpful every thumbs up and comment really does help me build this channel and hit that bell icon to be notified of my new videos every week and if you'd like to follow me on instagram or facebook at canadian t-shirt click the links in the box below or click the links on my homepage and be sure to tune into my next video on norbert's gambit where i'll be giving a step-by-step tutorial on how to buy u.s stocks without paying any currency conversion fees thanks everyone and i'll see you guys on the next episode of the canadian in a t-shirt bye guys

Channel: Canadian in a T-Shirt

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Id: gcYlQl6hF6w

Length: 14min 41sec (881 seconds)

Published: Wed May 06 2020