The impact of your marginal tax rate
It’s important to clarify, Ken, that if you have a minimum RRIF withdrawal with no tax withheld, that does not mean that income is tax-free. When you report your RRIF and other income sources on your tax return for the year, you may still owe tax.
Canada has progressive tax rates so that higher levels of income are taxed at higher rates. For example, in Ontario, the first $12,000 or so you earn has no tax. The next roughly $3,000 has 15% tax. And the next $36,000 of income after that has about 20% tax. The type of income you earn may change these rates, as will tax deductions and credits. But if we kept going to higher incomes, there would be incremental increases in tax rates.
If you have a higher income, your entire income is not taxed at the higher tax rate. Incremental tax rates lead to income being taxed at different rates as you move up through the tax brackets.
This is why retirees tend to have tax owing. If you have a $10,000 pension, you may have no tax withheld at source. But if you have $60,000 of other income, you might owe 30% tax on that pension income.
Getting ahead of tax installment requests
If you owe more than $3,000 of tax in two consecutive years (or $1,800 in tax for two years in Quebec), the Canada Revenue Agency (CRA) (or Revenu Quebec) will start asking you to prepay your tax for the following year. This is called a quarterly income tax installment request.
Installments—along with OAS clawbacks—tend to be the two cursed tax issues for retirees.
You can reduce your installments by requesting higher withholding tax on your CPP, OAS, pension or RRSP/RRIF withdrawals, Ken. This optional tax withholding might be preferable if you would rather not owe tax or prefer to limit your installment requirements. If you can get your withholding tax rate estimated accurately, you may be able to better spend money coming into your bank account because it is all yours, and not accruing a tax liability.
The choice is yours
Many retirees do not have sufficient tax withheld by default. So, quarterly tax installments are common at that stage of life. But owing tax does not have to be a given if you prefer to increase your optional withholding tax.
