Over-contributing to an RRSP: Good Idea?
A question I’m commonly asked is ‘is over-contributing to an RRSP good or bad? Did you know that the penalty is 1% per month on the full amount of the over-contribution. So be careful.
First thing to understand about RRSPs
The contribution limit for the next year is detailed in the annual Notice of Assessment (NOA) that the CRA provides after you file your tax return. Do not exceed this limit when you make your RRSP contributions to your or your spouses’ RRSP account. The CRA wants to get away from mailing paper and encourages everyone to use My Account to access their NOA. They also want to get away from answering any phone calls, but that is another issue.
Second thing to understand about RRSPs
Earned Income is the only thing that increases your RRSP limit from year to year and Pension Adjustments from your employer (if you belong to a pension plan) reduce the limit. You can still use RRSP contributions and any “Unused Contributions carried forward” to reduce Passive Income (Income from interest, dividends and capital gains etc.) in your tax return.
Third thing to understand about RRSPs
You can continue to contribute up to the time you are 70. After your 71st birthday you can no longer contribute.
Fourth thing to understand re RRSPs
You may over-contribute up to $2,000 and this will not be taxed. This is no good to you after you pass 71. You can also leave an unused over-contribution in place one year if you know you will need it next year. For example, if you receive a lump sum of cash and want to top up your RRSPs now, you can contribute now so that compound interest starts right away and use up the over-contributions in subsequent years. Bear in mind, this is dangerous as you might end up without enough income to be able to use past contributions. Then you have an over-contribution to deal with.
What to do if you retire and/or reach 70 and have an over-contribution outstanding.
The first and most obvious answer is to get the money out of the RRSP. This will be taxed by the financial institution as a withdrawal. Although you can ask CRA to waive the interest before-hand, this can only be done in the year after you made the contribution. Just get it out as soon as possible and keep the withdrawal slip as evidence for CRA that you removed the over-contribution.
The second is to report the over-contribution to CRA by completing form T1-OVP. This is the most complex piece of gobbledegook you are ever likely to encounter, but it must be done. You self assess the interest due on the over-contribution and have 90 days to send in the payment.
If you want to ask CRA to waive this interest you can try if you have sufficient reason. The reasons are detailed in form RC 4288: click here. The reasons that are considered adequate are extreme. “I was unaware” or “I did not understand” just do not cut it so do not waste time as interest continues to accrue.
Pay close attention to your NOA and provide it to your tax preparer annually.
Until next time,