Tax Tip Thursday

I have noticed a regular occurrence this year that is causing a lot of people a lot of grief, and I suspect it is going to run into 2021 as well!

People are taking a lot of money out of their RRSPs, receiving various kinds of COVID benefits, and establishing other sources of income (pensions, small businesses, etc).

This is great for your wallet, but can have some serious tax consequences!

RRSPs are the number one problem area for underpaying your tax, however. I don’t know why the government has created this situation, but they definitely have made it easy for people to fall into this trap. If you withdraw money from your RRSP, the bank or financial institution is required to hold back a certain amount of tax on the withdrawal. The problem is you can manipulate it (intentionally or unintentionally), and it is not in your best interest to do so!

These are the amounts the institution will withhold:

• 10% on amounts up to $5,000
• 20% on amounts between $5,001 – $15,000
• 30% on amounts from $15,001+

If this was your only income for the year, that would be fine. BUT, if you have earned other additional income through the year (such as from your job, pension, or small business), that’s where you can run into problems.

For example…

Let’s say your hours were cut back at work due to COVID or some other situation. Maybe you are still making 50% of your previous $50,000 income through the year (for a new total of $25,000), but that is not enough to support you. You decide to withdraw some money from your RRSPs even though you do not want to. Unsure of how the rest of the year is going to go, you withdraw $5,000. That money will be taxed at 10%, which is probably not a big deal. But then in June you find that you need more money, so you take out another $5,000. Same thing — this will be taxed at 10%. Maybe this happens two more times throughout the year, so you have withdrawn $20,000 but only paid $2,000 (10%) in taxes. Do you see where the problem is forming?

At the end of the year your gross income ends up being $45,000, from which you have paid $5,800 in taxes ($3,800 from your pay cheque and $2,000 from the RRSP). The issue here is that your tax payable on $45,000 is $9,100! That’s only 20%, which is not outrageous, but you didn’t pay that much! You are short $3,300, AND you were already broke to start with or you would not have taken the money from your RRSPs in the first place! So where are you going to find another $3,300 to pay your tax bill?

This is a terrible situation that I have been seeing a lot of people fall into.

It doesn’t stop at RRSPs, though.

This sort of issue also affects other situations, like the ones I mentioned earlier:

• People who draw more on their pensions,
• people who just retired and started to receive a pension,
• people who take on additional part-time work,
• or people who start a small business (especially service businesses).

If you are generating additional income in some way beyond your employment income, you can very easily (and will likely) find yourself in a similar jam at tax time!

So what can you do about it?

A mid year review is a good way to go about this. I do these for clients all the time — typically in the summer or early fall. I can calculate where you are in the year and estimate your tax bill for the following April! This has been very enlightening for a number of people, and has given them the knowledge to be able to do something about it because they still had eight months to plan for it!

The other thing that you can do on your own is just make sure you put 25-30% of your additional income (regardless of the source) away in a separate bank account — or even send it to the CRA right away. This may or may not be enough, but it will be a LOT closer to reality than doing nothing!

Are you stuck with a tax bill?

If you are stuck with a big tax bill because of situations like these and are having trouble finding a way to pay it, there is an option to not pay it immediately.

Disclaimer: I strongly recommend against this unless it is truly your only choice. It is a very slippery slope that can be extremely difficult to get out of.

If you made less than $75,000 net income in 2020 and you have a tax bill, the CRA gives you until April 2022 to pay your taxes owing. Again, I urge people to use this ONLY as a last resort, but it is available.

Looking for help with this?

I can help you! Whether you are stuck with a tax bill and are looking for ideas on how to avoid that last resort I mentioned, or are looking for help with the upcoming tax year, I am here for you. Give me a call!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.