How does withholding tax on RRSPs work?

Do you want to help investors maximize the long-term value of their retirement funds? You need to be knowledgeable about how to grow a Registered Retirement Savings Plan (RRSP). Plus, you should be able to create effective strategies so that your clients can minimize unnecessary losses. One often overlooked element is the withholding tax applied when funds are withdrawn from their RRSPs. 

Whether your clients are planning an early withdrawal or transitioning into retirement, knowing how this tax works is essential for effective planning. In this article, Wealth Professional Canada will discuss what financial advisors need to know about withholding tax on RRSPs. We will talk about the basics of RRSPs such as how they work and ways to avoid taxes on withdrawals. We will also provide answers to some concerns that you might have about this investment-slash-savings account. 

Is RRSP subject to withholding tax? 

Short answer: yes. When your clients withdraw funds from their RRSPs, a percentage of the amount is immediately withheld by the bank, credit union, or financial firm. This withheld amount serves as a prepayment of income tax. 

The tax rate depends on the amount withdrawn and whether your clients are residents or non-residents. Withholding tax does not apply if the funds are transferred directly to another registered account, such as a Registered Retirement Income Fund (RRIF). 

The withheld amount is then remitted to the Canada Revenue Agency (CRA). 

What is the withholding tax on RRSP withdrawals? 

Withholding tax on RRSP withdrawals is a tax that financial institutions must deduct at the time your clients take money out of their RRSPs. This applies to lump-sum withdrawals and is separate from the regular income tax that they must pay when they file their tax return. 

The withholding tax is meant to prepay a portion of the income tax owed on the withdrawal. 

How much of RRSP is taxable? 

All RRSP withdrawals are fully taxable as income in the year they are withdrawn. This means that your clients must include the full amount in their annual tax returns. While some tax is withheld at the time of withdrawal, the actual tax owing depends on their total income for the year. 

If they are in a higher tax bracket, they may owe more. Only contributions and growth stay tax-sheltered while funds remain in the RRSP. 

How much is the tax rate? 

It depends on how much is withdrawn and where your clients live.  

In Québec, provincial tax is also withheld along with these tax rates: 

• five percent on amounts up to $5,000 
• 10 percent on amounts over $5,000 up to $15,000 
• 15 percent on amounts over $15,000 

Throughout the rest of Canada, withholding tax rates are: 

• 10 percent on amounts up to $5,000 
• 20 percent on amounts over $5,000 up to $15,000 
• 30 percent on amounts over $15,000 

As for non-residents, they are subject to a 25 percent withholding tax on their RRSP withdrawals, unless reduced by a treaty. 

Some exceptions apply. For instance, withdrawals under these two programs will not be taxed: 

• Home Buyers’ Plan (HBP) 
• Lifelong Learning Plan (LLP) 

Either of these options will allow your clients to access their RRSP savings temporarily without immediate tax. However, repayments must be made on time, so be sure to remind your clients. 

Consequences of withdrawing from an RRSP before retirement 

Early withdrawals from an RRSP can cost your clients more than they expect. Below are the main consequences you should explain when discussing cash flow and long-term planning: 

Immediate withholding tax 

As discussed earlier, when your clients request a cash withdrawal that is not part of HBP or LLP, the financial institution must apply withholding tax. Also, the withholding amount is only a prepayment. 

The full withdrawal will be added to your clients’ taxable income for that calendar year. If the marginal tax rate is higher than the amount already withheld, the client will owe more when filing a return. If it is lower, a refund will be issued. Either way, the withdrawal increases reportable income. 

Risk of moving into a higher tax bracket 

For example, a mid-career client who withdraws a large sum might push their total income into the next tax bracket. This can raise their overall tax liability. 

Permanent loss of contribution room 

An RRSP’s contribution room doesn’t reset after withdrawal. Once funds leave the plan, the contribution space used to create that balance is gone for good. Re-contributing the same amount requires a new room generated by future earned income. 

Reduced long-term growth 

RRSP assets grow tax deferred. Even a small withdrawal can remove capital that would have been compounded for decades. For instance, a client aged 40 who withdraws $10,000 today could give up tens of thousands in future value, depending on market returns. 

Possible loss of credits 

Higher reported income in the withdrawal year can lower or eliminate credits such as the GST/HST credit. Investors can often overlook these indirect concerns. 

To avoid these consequences, encourage your clients to explore other funding sources such as a secured line of credit or a short-term loan before tapping into their RRSPs. If a withdrawal is unavoidable, tell them to plan the amount and timing to minimize tax impact, perhaps spreading withdrawals across two calendar years. 

Investors should also keep detailed projections that show the long-term cost of reduced compounding. Visualizing the forgone growth reinforces disciplined saving. By presenting these alternatives, you’ll be able to aid your clients in learning the true cost of early RRSP withdrawals and preserving their retirement assets. 

How does an RRSP work? 

An RRSP is a federally registered account that allows your clients to save for retirement on a tax-deferred basis. Contributions are tax deductible, lowering taxable income in the year they are made. All interest, dividends, and capital gains earned inside the plan remain untaxed until money is withdrawn. 

Your clients can contribute until December 31 of the year they turn 71. At that point, the RRSP must be collapsed, most often by transferring to an RRIF. Income can then be taken in scheduled withdrawals or used to buy an annuity. Each option is subject to normal income tax rules. 

Who can open an RRSP? 

Anyone under 71 years old can open an RRSP, as long as they have earned income and reported it on their previous year’s tax return. Contributions should be made before the end of each tax year to maximize tax-deferred growth. 

Investments inside an RRSP can grow without being taxed until the funds are withdrawn. Once your clients begin making withdrawals, the amounts are taxed as regular income in the year that they are taken out. 

For more about RRSPs in Canada, watch this: 

Do you have clients who made overcontributions to their RRSPs? Read this article to learn how you can help them with the withholding tax and more. 

What is the 3-year rule for RRSP? 

The attribution rule applies to the three-year period following a contribution to a spousal RRSP. If a withdrawal is made from the spousal RRSP within that period, the amount is taxed as income to the contributor rather than the annuitant. 

To avoid this, no contributions should be made to any spousal RRSPs in the year of withdrawal or the two preceding years. 

What is the best way to use RRSP? 

To maximize their RRSPs, your clients should make regular contributions during high-income years to capture the largest tax deductions. This can allow their investments to grow tax deferred. 

They should also schedule withdrawals when they’re in a lower tax bracket. This is usually done in retirement. Advise your clients to: 

• contribute as much as possible each year and save any unused contribution room for future years when cash flow is tight 

• use a spousal RRSP to split taxable retirement income between partners 

• keep funds invested until conversion to an RRIF at age 71, avoiding early withdrawals that lose tax sheltering 

• employ the HBP or LLP for specific goals without triggering tax, provided repayments are made on schedule 

Matching contribution timing with each client’s projected retirement tax bracket and cash-flow needs helps achieve the greatest long-term benefit from the RRSP structure. 

What is the average rate of return on an RRSP? 

The average annual return on an RRSP varies based on the investment mix. For example, a balanced portfolio might yield less than a growth-oriented portfolio. Returns can fluctuate depending on market conditions and investment choices. 

How risky is an RRSP?  

The RRSP alone is not naturally risky. The level of risk associated with it only depends on the type of investment that your clients choose. Investments made through RRSPs might come under these different risk categories: 

Low-risk options 

The types of investments under this category often include: 

• Guaranteed Investment Certificates (GICs) 
• savings accounts 
• government bonds 

While these options have lesser potential returns, they are considered safer due to government guarantees or being stored in secure financial institutions. 

Moderate-risk options 

This category includes mutual funds, which combine funds from different investors to invest in a broad portfolio of bonds and stock investments. The level of risk differs based on the type of mutual fund and its asset allocation. 

High-risk options 

Because of the potential for increased fluctuations, stocks and equity-centred investments are often seen as higher risk. The performance of the stock market might fluctuate rapidly in short periods of time. This can result in both possible gains and losses. 

Want to make sure that your clients won’t make critical mistakes in using their RRSPs? Watch this clip: 

Should your clients worry about withholding tax on RRSPs? 

Not necessarily. You must simply remind them that withholding tax on their RRSPs can reduce the value of their retirement savings. This is especially true if their withdrawals are not properly planned. So, unless there is an urgent need, they should avoid early or unnecessary withdrawals, since it’ll trigger immediate withholding tax and count as income in that year. 

When used strategically, the RRSP can be one of the most effective tools for tax-deferred growth and retirement planning in the country. If you want to be seen as a credible and reliable financial advisor, guide your clients in reviewing how and when taxes apply. You should also consider creating personalized strategies so that they can use their RRSPs wisely. 

For more information about RRSPs, check out our Retirement Solutions page.