Understanding Tax on Retirement Income

As a retiree, you may have noticed that you owe taxes when you file your return, unlike when you were working and usually received a refund. This is a common phenomenon, and it’s not just you – many pensioners face the same situation. But why does this happen, and what can you do about it?

Income Tax on Retirement Provisions

When you’re an employee, your employer withholds taxes from your paycheck. If you have no other income, deductions, or credits, you shouldn’t owe any taxes or receive a refund when you file your return. However, most people have tax deductions or credits that reduce their taxable income, resulting in a refund.

In retirement, the situation is different. You may have multiple income streams, such as a defined benefit pension, part-time work, rental income, or investments. The tax withholding on your pension is often based on the assumption that it’s your only source of income, which can lead to under-withholding. As a result, when you add up all your income sources, you may end up owing taxes.

Types of Income with No Withholding Tax

Some types of income don’t have withholding tax, which can contribute to under-withholding. These include:

1. Canada Pension Plan (CPP): No tax is withheld from your CPP payments, but you can request voluntary tax withholding when you apply for CPP or later.
2. Old Age Security (OAS): Like CPP, no tax is withheld from OAS payments, but you can ask to have taxes withheld. Some government benefits, like OAS, are income-tested and may be subject to clawback.
3. Registered Retirement Fund (RRF): The minimum required withdrawals from your RRF don’t have withholding tax, but you can choose to have taxes withheld. If you withdraw more than the minimum, the financial institution will withhold tax, ranging from 10% to 30% depending on the withdrawal amount.

Why the CRA Requests Income Tax Installments

If you consistently owe taxes, the Canada Revenue Agency (CRA) or Revenu Québec may request that you make advance payments of estimated tax. This can happen if you owe taxes in two consecutive years, and the tax owed exceeds a certain threshold. In this case, you may be required to make quarterly income tax installments, which are based on your tax owed in the previous two years.

What You Can Do

To avoid owing taxes in retirement, you can consider the following:

• Request voluntary tax withholding on your CPP or OAS payments
• Choose to have taxes withheld on your RRF withdrawals
• Make quarterly income tax installments if you’re required to do so
• Review your tax situation with a financial advisor to ensure you’re not under-withholding or over-withholding taxes

Conclusion

Understanding how taxes work in retirement can help you avoid owing taxes and ensure you’re not caught off guard. By knowing which types of income have no withholding tax and taking steps to manage your tax withholding, you can minimize your tax liability and enjoy your retirement with greater financial peace of mind. If you’re unsure about your tax situation, it’s always a good idea to consult with a financial advisor or tax professional to get personalized advice.