As we approach the fourth quarter of 2023, many may be expecting a year-end bonus payment from their employers. When you receive a bonus or any sort of lump-sum payment (such as vacation pay) from your employer, it is typically subject to a withholding tax. This means that a portion of your bonus is remitted to the government before it even reaches your bank account. You do have the option to contribute the net amount into your RRSP, provided you have sufficient contribution room. This contribution amount will be deducted from your taxable income, and upon filing your taxes, you will receive a refund or a reduction in the taxes you owe. To the surprise of many investors, there is a way to maximize that RRSP contribution by avoiding the initial withholding tax.

How to Avoid the Withholding Tax on Your Bonuses

You can request that your employer contribute all or a portion of your bonus or lump sum payment directly to your RRSP or your spouse’s RRSP as a spousal contribution. If your employer makes this contribution directly, the requirement to withhold income tax on that amount is eliminated. This could be subject to some conditions, such as your employer needing to have reasonable evidence to believe that you can deduct the RRSP contribution for the year. The exact requirements will depend on your employer, but they could ask for a copy of your Notice of Assessment, which indicates your RRSP deduction limit, or to sign a confirmation acknowledging that you can deduct the contribution.

Why is this Beneficial?

The primary benefit of transferring the bonus directly without withholding tax is that you can invest the full amount of the bonus rather than just the net after-tax amount.

Let’s look at an example of an employee with a marginal tax rate of 40% who expects to earn a $10,000 bonus. The employer is required to withhold $4,000 ($10,000 x 40%), and the individual would only have the net amount of $6,000 to invest in their RRSP. They would also need to wait until they file their tax return the following year to get any refund from the withheld amount. However, if the bonus was contributed directly to their RRSP, the full $10,000 can be immediately invested in a tax-deferred manner in their RRSP.

Although employers are not obligated to provide this service, it could certainly be beneficial in terms of immediate tax savings if they permit a direct contribution to your RRSP. We recommend consulting with a member of your human resources department and your financial advisor to ensure this strategy makes sense with your overall financial plan in mind.