TRANSFERRING A BONUS TO YOUR RRSP WITH NO TAX WITHHELD
As part of your remuneration, if you receive a bonus or other lump-sum payment, you might want to ask your employer to send them directly to your RRSP without withholding income tax.
HOW TO DO IT
When your company sends you a bonus or other lump sum payment (such as vacation pay or an ineligible retirement allowance), they must normally deduct withholding tax at source. If you have enough contribution room, you can then contribute the net amount to your RRSP. In the year you claim the deduction, the amount of your RRSP contribution can be deducted from your taxable income, lowering your taxes.
If you contribute to an RRSP, you’ll get a refund or a decrease in taxes owed the following year. There is, however, a method to make the most of your RRSP contribution. For spousal contributions, you can ask your employer to direct all or part of your bonus or lump sum payment to your RRSP or your spouse’s RRSP. Your employer may contribute directly to your RRSP. If certain conditions are met, you will not be required to withhold income tax on that contribution. The advantage of sending the funds immediately without withholding tax is that you can put the entire amount in your RRSP.
Let’s take a look at a hypothetical situation. Let’s say you get a $20,000 bonus this year and have $20,000 in RRSP contribution capacity. Assume you pay a 40 percent marginal tax rate. Since your employer is required to deduct $8,000 ($20,000 x 40%), if you contribute directly to your RRSP, you will only have $12,000 to contribute. If this is the case, you will save $4,800 ($12,000 x 40%). However, you will have to wait until next year to receive your refund and deposit the additional funds into your RRSP. As an alternative, if you asked your company to donate your bonus directly to your RRSP, it may contribute the entire $20,000 to your RRSP. This will help you to save $8,000 in taxes ($20,000 x 40%). The $8,000 tax savings will be in your RRSP, where it will grow tax-free until you remove the money.
The method is even more useful if you receive a bonus or lump sum payment early in the year. Obviously, assuming your income level is relatively constant. If your employer makes a direct contribution to your RRSP within the very first 60 days of the year, you will be able to deduct the contribution in the prior year. As a result, you will not owe tax on the bonus until the following year.
You should be aware that your employer will be deducting Canada Pension Plan (CPP) and Employment Insurance (EI) even if you receive a bonus or lump sum payment early in the year. By the end of the year, you may have already reached the maximum yearly CPP and EI benefit amounts. As a result, your RRSP contribution may be larger.
HOW IT WORKS
Your employer must have reasonable reasons to assume that you can deduct the RRSP contribution for the year. It may be sufficient for your employer’s records to provide a copy of your most recent Notice of Assessment (NOA). The NOA will show your RRSP deduction limit. Alternatively, your employer may ask you to sign a form confirming that you can deduct the contribution for the year. For this direct contribution, there is no CRA form to fill out.
The company is under no obligation to provide you with this service so as to reduce the withholding tax. In fact, some businesses may give you the amount minus withholding tax.
AN OPTION FOR LOWERING COMPENSATION WITHHOLDING TAX
You can also contribute to your RRSP during the year if you like. Tax withholding on your regular income, bonus or other lump-sum payment can be lowered by asking your employer. Your employer may ask you to give them authorization from the CRA to lower withholding tax. This way they will be able to cut withholding tax. You must submit a completed Form T1213, Request to Reduce Tax Deductions at Source, to the CRA in order to receive approval. Ensure that you attach supporting documentation. The CRA may reject your application if you haven’t filed and paid all of your prior tax returns.
Your employer can instantly contribute your bonus or lump sum payment to your RRSP. Furthermore, donating directly allows you to make your RRSP contribution sooner, substantially increasing the growth of your RRSP. Making early contributions will allow your RRSP assets to grow tax-deferred for a longer period of time.