What better way to stash money for later years than contributing to your Registered Retirement Savings Plan (RRSP), right? Having a regular savings plan for retirement is an affordable and flexible option which allows you to reap its benefits once you hit the pension years.
You can contribute every month or annually. But the question is, how much is too much and is there such a thing?
What happens in the case of RRSP overcontribution?
Let’s find out.
What Happens if You Overcontribute to RRSP?
An overcontribution to RRSP happens more often than people think. It’s easy to lose sight of these payments, thinking you’ve got them in line. The irregularities may also happen if you contribute to your spouse’s RRSP while not having a complete insight into their current RRSP contributions.
Just when you’re about to file your taxes, you might discover that you’ve overcontributed and think now what?
One of the numerous advantages of Registered Retirement Saving Plans is the flexibility in choosing how much you want to contribute. However, that’s not to say you can go overboard with investing money without limits.
There is an upper limit to how much you can contribute to your RRSP, set by the CRA—Canadian Revenue Agency.
Here’s how it works. There is a buffer of $2,000 in how much you can overcontribute. It means that once you reach the RRSP limit, you have room to wiggle by as much as $2,000. But if you exceed the RRSP overcontribution limit of $2,000, then penalties will follow.
The RRSP overcontribution set by the CRA is calculated each year and is based on your total income for the previous year. Your total annual income includes revenue from your employment, self-employment or other taxed sources such as rental income. Furthermore, if you have specified pensions plans (SPP) and pooled registered pension plans (PRPP), it’s also added toward your annual income for the previous year.
Each year the percentage of the RRSP limit may vary. For example, for the current year (2022), the RRSP limit is 18% of your net income from the previous year—or $29,210. For the following year (2023), the limit will be $30,780.
Let’s take the limit of $29,210 for the current year to illustrate how it works. Assuming you’ve reached the RRSP contribution of $29,210, on top of that, you have an allowance of $2,000. It means that you can overcontribute to RRSP $2,000 over the $29,210 limit.
If you stay within the $2,000 RRSP overcontribution limit or below, you’ll pass the overcontribution without a penalty and you’re allowed to keep the money in your RRSP. However, keep in mind that this amount is not tax deductible. So you must be very careful about how much you put toward your RRSP.
The Canadian tax law states that anything over the RRSP contributions limit, plus exceeding the $2,000 overcontribution limit, is subjected to penalties.
You can always check your CRA account to ensure that you haven’t made an overcontribution to RRSP. If you have overcontributed, you’ll receive a notice of assessment showing how much you have exceeded the RRSP overcontribution limit and the taxes you owe.
With all that has been said above, many people use the $2,000 cushion to contribute more money to their RRSP. But using the RRSP overcontribution strategy is very tricky because you might overestimate your contributions and pay unnecessary penalties.
How Much Is the Penalty for Overcontributing?
We have already explained what happens if you overcontribute to RRSP. If you have reached the RRSP contribution limit, you’ll be paying penalties for every cent that exceeds the $2,000 buffer.
The RRSP overcontribution penalty amounts to 1% per month for every month of the overcontribution. Assuming you have been overcontributing for five months, 1% will be added as a tax for each of the five months. The penalty starts to count the month you’ve made the first overcontribution to RRSP.
It might not seem like a lot, given that there might have been only a few months of overcontribution. However, a multi-year overcontribution can significantly add to the penalty you will be paying. That being said, the 1% penalty will keep adding to your taxes until you withdraw the overcontribution excess.
But what happens if you have overcontributed by accident and don’t notice until late in the year? With the start of the new year, your RRSP excess contribution becomes retroactive.
For instance, if you’ve overcontributed $3,000 for November, the excess amount is $1,000. This means you’ll be paying 1% of the said amount in penalties—in our example, an $1,000 overcontribution equals $10.
It’s best to make, for each year you overcontribute to RRSP, penalties will be adding up until you fix the problem.
What to Do in Case of an RRSP Overcontribution?
The first step to make sure you have or have not overcontributed is to check your CRA account. That way you’ll know if you’ve crossed the limit cap and take actions to settle your balance.
The next step is to report your overcontribution to the CRA by filing a T1OVP Individual Tax Return. If you fail to do this, the CRA will eventually notice that you’ve crossed the RRSP overcontribution limit, but it might be a year later or two. In the meantime, the penalty interest will only keep adding up.
But don’t worry; CRA offers an RRSP overcontribution strategy to help you fix the situation and clear your contribution excesses.
Let’s check out how that works.
How to Fix an RRSP Overcontribution?
You have several options to minimize the penalties for your excess RRSP contribution. If you follow the strategies provided below, you should be able to have CRA waive tax on your overcontributions.
Pay the penalty
Once you realize you’ve made an overcontribution to RRSP, the first step is to pay the penalties. You must find the year you’ve crossed the limit cap to do that.
We’ve already mentioned that you must log in to your CRA account to see if and how much in overcontributions you made. You should collect the overcontributions for each year and provide this information to the CRA. You’ll be able to find this information on the Notice of assessment that you receive from the government.
On the Notice of assessment, you’ll see information about your RRSP deduction limit. You can then use this info to help you calculate your RRSP contributions and compare them to your deduction limit for that year.
To report the RRSP overcontribution to CRA, fill out the T1-OVP Individual Tax Return form for RRSP, PRPP, and SPP excess contributions. You have 90 days to pay the penalty; otherwise, you’ll face additional charges for late filing. The late filing is counted from the 91st day of the time limit to pay off your penalty.
If you miss playing the penalty for the time of your overcontributions after the 90-day mark, you will be charged 5% of your balance and the additional 1% penalty. These charges apply for as long as 12 months that you’ve been late with filing penalty. So, if you have been late with filing the penalty for a full year, a 1% penalty will be added for each month, plus the 5% charge. The more years you are late with filing the penalty, the higher the charges.
Resolving the problem requires showing effort and taking active steps to avoid future mistakes.
Withdraw the excess contribution
You can ask the CRA for a tax waiver by filling out a T3012A form for excess RRSP contribution withdrawal.
This is a handy RRSP overcontribution strategy to fix the problem immediately. However, you must prove to the CRA that you have made an honest mistake. They will ask you to explain the reasons for the overcontributions. By providing enough proof and using the T3012A, you’ll be able to withdraw the excess overcontributions and waive the tax on the surplus amount.
To withdraw the excess amount from your RRSP contributions, you must:
- Explain to the CRA that you have made an honest mistake by providing documentation or paperwork to prove that;
- Gather copies of your RRSP, PRPP, and SPP or RRIF statements where it shows that you have made the withdrawal;
- When you’re filing your tax return, you should also include the withdrawal in income;
- Then, complete the T3012A form and, along with the documentation mentioned above, send it to the CRA.
However, remember that the amount you withdraw from your overcontributions is still taxable. To claim a tax deduction, you must withdraw the amount in the same year you’ve made the overcontribution to RRSP.
Prove the contributions were to a qualifying group plan
A qualifying group plan is essentially the contribution amount required to put towards PRPP. It is a mandatory group plan for two or more individuals who are entitled to the amounts they have been contributing. These payments should then be sent (paid) to the RRSP either by the person who pays you or that person’s agent.
However, If you still have remaining allowances from previous years for which you haven’t reached the limit, the CRA allows you to carry over those allowances into the next months. This means that the difference between the contribution amounts you made in previous years and the maximum allowance for each will be added to your limit for the current year.
If, in the meantime, your income has increased or there has been a change in your pension, it can change your contribution limit cap as well. Whenever there are changes in your pension, you should make a pension adjustment. While moving money between pension plans is not calculated towards your limit cap; however, any contributions made to PRPP and SPP are.
As we can see, it’s easy to lose insight into your RRSP contributions and exceed the limit cap. Not only that, but to exceed the $2,000 allowance as well. Overcontribution to RRSP is penalized.
The RRSP overcontribution penalty is 1% for each month you have made the overcontributions for. However, you have options to fix that by withdrawing the excess contributions, paying the penalties or proving that it was due to the contributions for a qualifying group plan.
While some intentionally use the buffer of $2,000 to maximize their RRSP contributions, refrain from doing that. You’ll get yourself in unnecessary trouble and end up paying needless penalties.
You can withdraw the excess amount and ask the CRA to waive your tax by providing them with proof that you have made an honest mistake. Note that you will be subjected to an RRSP overcontribution penalty for as long as you get the certification of your claim from the CRA.
You can also opt for paying the penalty for the months you have overcontributed or prove the contributions were to a qualifying group plan.
You may get an income tax refund for your overcontributions if you meet certain criteria. This is because when you contribute to your RRSP, it reduces your taxable income for the current year.
While with RRSP you have wiggle room of $2,000, that is not the case with TFSA. If you have reached your cap limit for the current year, but you have overcontributed with over $2,000, and haven’t corrected that by the end of the year, you’re subjected to penalties.
The penalty for TFSA overcontribution is the same as for an RRSP overcontribution, 1% for each month of overcontribution.