Q: My wife and I are planning to retire within five years. I heard about a rule that requires you to stop contributing to your RRSP for three years prior to withdrawals in order to avoid a tax penalty. Is this true? And how does it work exactly?”—Marty Patterson Thunder Bay, Ont.
A: RRSP withdrawals are always taxable, unless you’re making a withdrawal under the Home Buyers’ Plan (HBP) to buy a home or the Lifelong Learning Plan (LLP) to go to school.
If you withdraw up to $5,000, there is 10% withholding tax. Withdrawals of $5,001 to $15,000 have 20% withheld. Thirty per cent tax applies to withdrawals over $15,000. RRSPs are then taxed on your tax return and tax withheld is credited accordingly, so it may ultimately result in a refund or balance owing.
If you make the minimum required withdrawal from a Registered Retirement Income Fund (RRIF), tax is not withheld at source, but it’s still taxable on your return.
The three-year restriction you are referring to applies to spousal RRSP withdrawals. If you contributed to a spousal RRSP for your wife in any of the previous three years and she makes a withdrawal this year, it’s taxed on your tax return instead of hers. This is called attribution—the withdrawal is attributed back to you, the contributor.
This may or may not be a problem for you, Marty. It’s not really a penalty, but you need to be aware of it so as to avoid unexpected tax consequences.
Jason Heath is a Certified Financial Planner (CFP) at Objective FinancialPartners Inc. in Toronto.