How to manage your tax withholding in retirement

If it makes you feel any better, it is not just you—lots of retirees are in the same situation. Why does this happen, and what can you do about it?

Income tax on retirement benefits

When you are an employee, your employer must withhold payroll tax at source. If you have no other income, deductions or credits, in theory, you should have no tax owing nor a tax refund when you file your tax return in April.

In practice, most people have tax deductions that reduce their taxable income, or tax credits that reduce their tax owing. Both lead to tax refunds, and this is why most Canadian taxpayers get money back when filing tax returns during their working years.

In retirement, the situation is different. For one, taxpayers tend to have multiple streams of income. If you have a defined benefit pension, for example, the tax withholding is based on the presumption that it is the only income source you have for the year. As a result, if you have other income from part-time work, rental income or taxable non-registered investments, the tax withheld on the pension will generally be too low.

In addition, some types of income do not have any withholding tax. For example:

Canada Pension Plan (CPP): There is no withholding tax required for your CPP payments. If you want voluntary tax withheld, you can indicate this when you apply for CPP or later on as well. So, it is not a one-time decision.

Old Age Security (OAS): As with CPP, there is no requirement for Service Canada to withhold tax from OAS payments, and you can ask for tax to be withheld. Some government benefits, such as OAS, are means-tested, and may be subject to a clawback. (More on this below.)

Registered retirement income fund (RRIF): The minimum required withdrawals from your RRIF (and similar tax-deferred retirement accounts) do not have tax withheld. You can elect to have tax withheld, and if you take withdrawals beyond the minimum, the financial institution has to withhold tax ranging from 10 to 30% depending on the amount withdrawn.

As a result, most retirees end up owing tax.

Why does the CRA ask for income tax installments?

If a taxpayer consistently owes tax, the CRA—and Revenu Québec for Quebec residents—may ask for prepayments of estimated tax owing.

For non-Quebec residents, if tax owing exceeds $3,000 in two consecutive years, this triggers a request for quarterly income tax installments. These are suggested payments of tax for the current tax year based on the two previous tax years.