RRSP Contributions – Have You Over-Contributed?

Registered Retirement Savings Plans (RRSPs) can be a great retirement planning tool for many Canadians, but they may also be costly for the unwary. If you have over-contributed to your RRSP, certain problems can arise.

The Penalty

A penalty tax is applicable, even though the over-contribution has never been deducted from taxable income. This tax is due to the fact that the income earned on your over-contribution is earned within a registered plan; therefore, the income accumulates in your RRSP tax-free until withdrawn. The penalty tax is equal to 1% per month of the over-contributed amount. This tax is not calculated on your annual personal income tax return, but on form T1-OVP, which is due by March 31 of the following calendar year. The form is applicable the moment you have over-contributed regardless of future corrections to the amount. It is important to note that the liability to pay this tax can never be statute-barred if a T1-OVP is not filed.

The CRA does have the authority to waive the tax where the taxpayer can demonstrate the over-contribution was inadvertent and steps were immediately taken to correct the problem. This waiver is entirely at CRA’s discretion.

Double Tax

The second problem with an over-contribution is the possibility of double tax. If subsequent years’ RRSP room will not be sufficient to allow for the eventual deduction of the contribution, then you may pay tax on the amount twice; first when you earned the income and again upon the eventual withdrawal of the funds from your RRSP.

The Fix

Upon realization of your over-contribution, there are three avenues you can take. The first is to determine whether the following year’s RRSP room will be sufficient to use up the over-contribution and determine if you are willing to wait until it corrects itself (the penalty tax will still apply while over-contributed). If applicable, you should also ensure you stop your (or your employer’s) automatic RRSP contributions to allow for the absorption of the over-contribution to ensure you do not have an ongoing problem.

The second option is to withdraw the funds immediately. The withdrawal of funds will result in tax being withheld and the issuance of a T4RSP slip. This withdrawal must be reported as income in the year of withdrawal; however, you may be able to deduct it in the year of withdrawal by filing form T746 with your tax return, resulting in a tax neutral situation. The immediate withdrawal is the important step here as this deduction is only allowed when the amount is withdrawn in the year of contribution or the following year, or in the year of assessment of the tax return in which the over-contribution was made or the subsequent year. You are not allowed to make a series of over-contributions and withdrawals.

The third alternative of course, is to do nothing, which is frankly, never a good idea.

Care should be taken to fully understand the RRSP room available to you. If you find yourself over-contributed, you must weigh which option is best suited for your individual situation.