Understanding the rules
by Jamie Golombek
It's been over just two years now since the Canada Revenue Agency (CRA) officially changed its administrative policy with respect to the correct methodology to be used to charge withholding tax on registered retirement income fund (RRIF) withdrawals. Yet, some advisors may still be unfamiliar with the new rules. Before delving into them and presenting some examples of their application, a short review of the basic rules is in order.
The withholding tax rules
As all advisors know, under a RRIF, a predetermined minimum amount must be withdrawn each year. This amount is determined under the Income Tax Act and is based on the fair market value of the RRIF on January 1st of each year. While no income tax is withheld on this minimum amount, any excess of the minimum amount is subject to withholding tax at the following rates:
10 per cent if the withdrawal is not more than $5,000;
20 per cent if the withdrawal is more than $5,000 but not more than $15,000; and
30 per cent if the withdrawal is more than $15,000.
Note that if your client will not have any income tax liability at all for a particular year, perhaps because her income is below the basic personal amount, she may complete CRA Form TD1 Personal Tax Credits Return, certifying that her total eligible tax credits will be more than her taxable income for the particular year.
Instalments Of A Single Amount
Often, clients will request to receive RRIF payments on a regular or periodic basis, say monthly or quarterly. The CRA's relatively "new position" on such periodic payments, which are considered to be instalments of a single amount, is that the rate of withholding to be applied on each individual payment should be based on the total sum requested and not on each individual payment. If, however, the client requests an additional lump-sum amount to be withdrawn during the year, the withholding tax rate based on that lump sum can be used and the periodic payments already taken out need not be considered when determining the correct withholding tax rate to be applied.
These new rules can be somewhat confusing, and thus, in late 2005, the CRA released a series of questions and answers on how these rules are to be administered. Below is a summary of the key issues, presented in the form of various scenarios.
Scenario 1: Natasha has elected to receive RRIF instalment payments of $1,500 per month for a total of $18,000 during the year, which is in excess of her minimum amount. Under the old rules, many financial institutions would have charged only 10 per cent tax on each $1,500 withdrawal; however, under the new rules, a 30 per cent tax rate must be applied to each RRIF instalment.
Scenario 2: Rob requested equal monthly payments from his RRIF of $1,000. Since the annual total is above $5,000, each payment would be subject to a 20 per cent withholding tax. In April 2006, Rob needed to withdraw an extra $4,000. As per the CRA's policy above, the additional $4,000 is considered to be a separate request and therefore only 10 per cent need be withheld on the $4,000 withdrawal.
Scenario 3: At the beginning of the year, Joe requested that an annual amount of $7,200 be paid out of his RRIF in equal monthly instalments. His minimum amount for 2006 is $1,200. As a result, each monthly payment of $600 includes a $100 minimum amount. Consequently, 20 per cent should be withheld on the $500 monthly amount in excess of the monthly minimum of $100.
Scenario 4: Ronnie originally requested that his RRIF payments for 2006 of $7,800 be paid to him monthly. Assume that each monthly payment of $650 includes a $50 minimum amount. In July 2006, after receiving six monthly payments, Ronnie now wishes to reduce his payments for the remaining six months to $100 per month in excess of the minimum. This effectively changes his yearly amount subject to withholding tax to $4,200 (i.e., 6 X $600 + 6 X $100).
According to the CRA, in this case, the lump sum rate of 20 per cent that was previously being used should be reduced to 10 per cent because the "revised payments are simply a continuation of [Ronnie's] initial request [one lump-sum amount split into instalments] and not a separate payment".
Alternatively, the RRIF provider can recalculate the revised annual figure to determine if there is a change to the tax rate and then determine the amount of tax required on the remaining payments in the year while taking into account the tax that has previously been deducted.
In Ronnie's case, since sufficient tax was already deducted on the payments he received during the first six months of the year, no further withholding tax is required on the remaining payments. This can be proven as follows:
Tax required on the revised annual figure:
($4,200 x 10%) = $420
Less: tax withheld on the first six months:
($3,600 x 20%)= ($720)
Overpayment of tax:
($300)
This overpayment will be refunded to Ronnie when he files his 2006 tax return, assuming no other tax is owing on other sources of income.
Scenario 5: Donna walks into your office on Monday and requests $1,000 from her RRIF. She does the same thing on Tuesday, Wednesday, Thursday and Friday. In this case, the CRA views all these requests as instalments of a single request and the withholding rate for the total should be used.
Finally, remind clients that no matter how the withholding tax is calculated, it is only an estimate of tax ultimately owing, which will be calculated when they file their tax returns for the year.