Paying Your Income Taxes in Retirement
When making the transition from your working years to retirement, a common concern or question that comes up is, “How do I pay my taxes in retirement?”
I had this conversation with two clients recently as many retirees are unsure of how taxes work in retirement.
- As a retiree you pay your income taxes during the year by:
- Withholding taxes on your income and/or paying installments to the CRA.
- paying installments to the CRA.
- Withholding tax means that part of your income is “withheld” and paid to the CRA. This is like when you were working and part of your income was deducted and submitted on your behalf as tax to the CRA.
- You will have to pay installments during the year if the tax owing is more than $3,000 for 2022, or either 2021 or 2020. Installments are paid quarterly (March 15, June 15, September 15 and December 15) and are often based on the tax amount outstanding the prior tax year.
- Income in retirement may have withholding taxes set as:
- Required minimum set by CRA, It is up to you to set the amount, None.
- It is up to you to set the amount, None.
- For those sources that have a required minimum withholding tax, the amount of tax withheld does not take into consideration your entire taxable income for the year.
- You can set the withholding tax at any rate above the minimum required by the CRA.
- Non-registered investment income does not have any withholding taxes.
- Rental and self-employment income does not have any withholding taxes.
Sources of Retirement Income
Once you retire, determining the amount of tax you must pay can be challenging as you may have numerous sources of potential income such as:
- Old Age Security and Canada Pension Plan
- Company pension plans
- RRSPs, Locked-in RRSPs
- RRIFs, LIFs
- Tax free savings accounts (TFSAs)
- Annuities and guaranteed income products
- Non-registered investment accounts
- Self employment income
- Rental income
- HOLDCOs income
For many of the above sources, it is up to you to determine how much tax to have withheld (paid to the CRA during the year), and/or pay your taxes in installments during the year.
The Tax Puzzle
Paying taxes in retirement is like a puzzle in that various types of income are taxed differently. Unlike when working, the amount of tax that is withheld and paid to the CRA can be variable, resulting in retirees not paying enough tax during the year.
There are two ways to pay income tax during retirement:
- Tax withheld at source and/or
- Paying your income tax by installments.
Tax Withheld at Source
While working, when you were paid by your employer, taxes were withheld and sent to the CRA. At year end you received a T4 tax slip for employment income, and it showed your gross income as well as taxes you paid during the year.
In retirement, some sources of income (CPP/OAS, RRIF, etc.) may have tax withheld on the income you receive.
For investment income, self-employed income, and rental income, there is no income tax withheld. As a result, you may be required to pay installments during the year if you owe taxes when you file your income tax return.
If you must pay installments, that means you have not paid enough tax during the year and owe money when you file your income tax return. If you are required to pay installments and don’t pay enough, a penalty may occur.
If your income declines in retirement, and you need to change the amount of installments, you can use this FORM to help you.
To learn how your income is taxed in retirement, you can read the complete article on Jack Lumsden’s Blog.
For more information, you can refer to Preserving Wealth: The Next Generation - The definitive guide to protecting, investing, and transferring wealth by Jack Lumsden, MBA, CFP®
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