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
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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