Contributing to a registered retirement savings plan (RRSP) can be a great way to save for retirement while minimizing your tax burden during your working years. But over-contributing to your RRSP can cost you dearly in penalties and interest charges. Find out how to prevent over-contributing and what to do in case you do.
What is an RRSP over-contribution?
An RRSP over-contribution occurs when you contribute more to your RRSP (or spousal RRSP) than your deduction limit and the $2000 buffer.
Your contributions include any direct contributions you make to a registered retirement savings plan, contributions to a specified pension plan, and pooled registered pension plans.
Determining your RRSP deduction limit
Your RRSP deduction or contribution limit is calculated according to your income and listed on your annual Notice of Assessment. Typically your RRSP deduction limit is 18% of your gross yearly income up to a specific limit.
The Canada Revenue Agency (CRA) also has a $2000 buffer over and above your RRSP deduction limit. But this buffer is not tax-deductible. You can take advantage of it but cannot claim it as a tax deduction.
How does it happen?
There are a few ways in which a registered retirement savings plan over-contribution can happen. The most obvious one is intentionally contributing more than your deduction limit.
Sometimes, however, over-contributions aren't as intentional. If you have more than one RRSP account or more than one employer contributing to your plan, mistakes can happen. It may seem like you have not exceeded your limit in one account, but your deduction limit includes contributions to all RRSP accounts, whether they are made directly by you or your employer.
Another way that RRSP over-contributions can occur is by failing to account for your pension adjustment. Your RRSP deduction limit is 18% of your gross salary. But if you have a pension (either defined benefit or defined contribution), that limit may be lower due to the inclusion of your pension contributions.
What are the penalties for over-contributing to an RRSP?
The penalties for over-contributing to your RRSP can really add up over time.
If you over-contribute within the $2000 buffer, there is no penalty. But if you contribute more than your limit plus the $2000 buffer, there is a 1% per month penalty that starts the month of the over-contribution.
You will then need to pay the penalty and file the appropriate form (T1-OVP – Tax Year Individual Tax Return for RRSP, PRPP, and SPP Excess Contributions) within 90 days after the end of the calendar year (typically the end of March). If you don't meet this deadline, you will also be subject to a late filing penalty of 5% of the balance owing plus 1% of the balance for each month you're late (up to a maximum of 12 months) and an interest penalty. The CRA calculates interest daily starting on day 91.
So essentially, you have 90 days to fix the problem, pay the penalty, and fill out the appropriate forms if you want to avoid the hefty late filing penalties.
How to correct an RRSP over-contribution and minimize penalties
There are a few ways you can correct RRSP excess contributions to minimize your penalties. Which way will apply to you will depend on when you discovered the over-contribution as well as the specifics of your personal situation.
If you notice the over-contribution before the end of the calendar year
If you notice the excess RRSP contribution before the end of the year, the first step you will want to take is to withdraw the extra amount immediately. This withdrawal is subject to a withholding tax and potentially further tax when you file your annual tax return.
To avoid the withholding tax, you can complete a T3012A form and send it to the CRA to certify. Once your T3012A is certified and passed on to your RRSP provider, you can withdraw the excess contribution amount without withholding tax. If you are going to go this route, do it as soon as possible. The 1% penalty for your over-contribution accrues as soon as the excess contribution occurs.
If you notice the excess contribution after the tax year
Noticing the excess RRSP contribution after the tax year is not the ideal scenario, but there are still ways you can minimize some of the penalties.
First, you will want to file your T1-OVP form and pay the 1% penalty within the first 90 days of the following calendar year. This will help you avoid any late filing penalties.
Once you pay the 1% penalty and complete the appropriate forms, your over-contribution then rolls into next year's deduction limit. Be careful to include them when calculating your deduction limit for the following tax year. You won't want to over-contribute 2 years in a row.
And if you have no income or accrued RRSP deduction room in the following tax year, then you will need to withdraw the over-contribution and pay the appropriate penalties. This is by far the worst-case scenario.
If you have contribution room in a home buyers' plan repayment
If you withdrew money from your RRSP as part of the Home Buyers' Plan (HBP) and are currently repaying it, you can designate the over-contribution as an HBP repayment. This will eliminate any penalty you may incur.
But the designation needs to be done within the appropriate tax year. If you realize the over-contribution too late, this option may not be available to you.
Can the CRA waive the penalty?
Yes, there is the possibility that you can get the penalties waived by the CRA. But a few conditions have to be met.
First, the excess contribution has to be due to a reasonable error. And you have to have taken or are taking reasonable steps to eliminate (withdraw) the over-contribution. The CRA will determine what is reasonable in both conditions.
How to get the penalty waived
If you meet the above two conditions, you can submit a request in writing to have the CRA waive the penalties for your over-contribution.
In your letter, be sure to detail why there was an over-contribution and why you believe it was a reasonable error. Along with your letter, include any correspondence you may have that validates your reasonable error, as well as copies of your RRSP, PRPP, SPP, and RRIF statements showing the withdrawal of any excess contributions.
Preventing RRSP over-contributions and penalties
The best way to avoid any penalty for an excess contribution is not to exceed your deduction limit. Here are some tips to help prevent an RRSP over-contribution:
- Monitor your CRA MyAccount and pay special attention to your RRSP contribution limit and annual Notice of Assessment.
- Track your RRSP contributions from all sources monthly
- If you notice an over-contribution withdraw the amount immediately and reach out to the CRA for assistance.