Q: I retired at 55 and I am collecting my full teaching pension. I have recently accepted a full time three month teaching position.
What factors should I consider when deciding how much extra money to have deducted each month so I’m not hit with a large pay back sum come tax time?
A: When you work as an employee for an employer, they are required to withhold income tax based on Canada Revenue Agency (CRA) or Revenu Québec payroll tables. If you have extraordinary tax deductions or credits, you can file a request to reduce tax deductions at source rather than waiting until you file your tax return to get a tax refund.
On the other hand, you can also ask your employer to withhold additional income tax for any reason, including if you have other sources of income that will create a tax liability, Kersten.
Income tax in Canada is progressive, so that higher incomes are taxed at increasingly higher rates. As your income moves into a higher “tax bracket”, that portion of your income is taxed at that higher rate.
In your case, Kersten, your new employer’s tax withholding will be based on the assumption that the salary is your only source of income. The same assumption will apply to the tax withholding on your pension. When all the income is added together on your tax return, the low tax withholding will likely be lower than your actual tax owing.
Some people don’t care about this and just budget to pay their tax owing when it comes due. However, if you consistently have tax owing, you may have to pay quarterly income tax instalments. In fact, if you owe more than $3,000 of tax in two consecutive tax years – $1,800 for Québec residents – the CRA or Revenu Québec will send you instalment notices. These notices are for estimated payments for March, June, September and December towards your estimated tax owing for the next year. You don’t have to pay, but if you don’t, and you owe tax, you will be charged interest at 6% currently.
If this is just a three month contract, Kersten, you could always just budget for potentially owing a bit of tax come next April. Or if you prefer, ask your employer to increase the withholding tax by X dollars, with X being a number you need to figure out with input from your accountant or by using an online tax calculator to get a sense of how much extra tax you need withheld.
Another consideration is that you may have some accumulated Registered Retirement Savings Plan (RRSP) room that you have carried forward. If you have extra cash flow and your income and tax rate are higher now than they will be in the future, an RRSP contribution may help offset the tax payable on the additional income.
Regardless, Kersten, your situation highlights the importance of tax planning. Sometimes, untaxed income or income taxed at a low rate can lead to a tax liability, particularly for pensioners and retirees. Try to plan ahead to anticipate any tax owing and consider the relative merit of higher source deductions versus owing tax and possibly being asked to pay quarterly instalments.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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