Wednesday, 26 April 2017

Fixing an RRSP Over-Contribution

What to do about an RRSP Over-Contribution

RRSP's can be a valuable tool when saving for retirement, not only do they give you a tax refund when you contribute, they also allow your money to grow tax-free until you withdraw it. I've talked more about the details of RRSP's both here and here

As a quick recap, every year that you work you earn contribution room. The amount works out to 18% of your annual income up to a maximum amount set by the government; for 2017 it is $26,010. If you don't use your room, it does carry-over for future use. To figure out how much room you have you can look to your most recent notice of assessment, it will be listed on there, or you can log in to your CRA online access. You might think you have tons of room available but keep in mind that if you are contributing to a pension plan through your employer that also counts towards your limit. 

CRA gives you a cushion of $2,000 (lifetime) in case you do exceed your contribution room. If you do use that amount you won't have to pay any penalties but you won't get the tax refund on that excess. It will still grow tax-free in your RRSP though. The problems arise if you go over and above that $2,000 cushion. The CRA is really punitive in their penalties, and you will be looking at a 1% charge PER MONTH, which can add up real fast. That means you will want to get on top of the issue and fix it ASAP. This is the same penalty you have to pay if you go over your TFSA contribution limit, but there isn't even a cushion for that. 

If you do find yourself in the situation of putting too much into your RRSP, then you will want to work fast. There's a chance you'll figure out your mistake yourself before CRA even knows about it. Usually, it would come up when you're doing your taxes. If not then you'll end up getting a letter in the mail from CRA informing you of your screw-up. Isn't mail from CRA the worst? Even when you're pretty sure it's just your notice of assessment there's always that moment of dread when you tear open the envelope! Whenever you do learn about the over contribution, you will want to act fast to fix it and avoid any unnecessary penalties. So how exactly do you do that? Well, you have two options...

1. Pay the Penalty
You can choose to leave the excess contribution in your RRSP and pay the penalty. This might be an option to look at if you hold an investment that has been doing really well or if the amount owing isn't that substantial. 
If you are choosing this route, you will need to fill out and submit form T1-OVP which will determine how much you owe. Try and do this within 90 days of the year after the over-contribution was made otherwise you may have to pay interest and a late-filing fee. That means that if you contributed too much in 2016, you would want to make the payment within the first 90 days of 2017. 

2. Withdraw the excess and beg for forgiveness
The second option, and likely the one you will go with, is to pull out the excess amount from your RRSP and then write a letter to CRA indicating why the over-contribution happened in the first place and provide proof that you have corrected the situation. The sooner you can make this happen the better. Now, to make things even more confusing, you have two options when it comes to withdrawing the funds.
  • Pay the tax: The easiest and fastest option is to contact your financial institution and have them pull out the amount you are over-contributed by. In this scenario, they will need to withhold tax based on the size of the withdrawal. If the withdrawal is under $5,000 it will only be 10% tax, if it's between $5,000 and $15,000 it is 20% and anything over $15,000 is 30%. If you need to withdraw more than $5,000 you can request that it be broken down into multiple transactions to keep the tax at 10%. The tax paid will count towards your next tax return, so you will get the money back at that point. 
  • Complete a T3012A to avoid the tax on the withdrawal: Your other option is to complete the tax deduction waiver form, and your financial institution will not have to withhold any tax on the withdrawal. Honestly, the form is a bit of a pain. You need to fill it out (potentially with the help of your accountant for a fee), send it to CRA for approval, receive it back and then forward it to your financial institution for processing. 
Whether you choose to pay the tax or get permission to skip it, you will need to submit proof of the withdrawal (account statement) along with form RC4288 to CRA to see if you can get the over-contribution penalty waived. Make sure you provide a detailed summary of what happened and why the over-contribution was an honest mistake. Hopefully, they will accept your explanation and see that you corrected it as soon as possible and will waive the penalty. 

Obviously, whatever option you choose, the whole process is a complete pain so avoiding an over-contribution is always the best option. Pay attention to your notice of assessment and ensure you aren't going over your contribution room at any time during the year. If you are making automatic payments to your RRSP every month (yay for you!) make sure they still make sense and don't need to be lowered because you are suddenly contributing to a pension plan or your income has changed. Most financial institutions only submit information to CRA early in January, so if you catch a mistake early enough they might be able to correct it internally, and CRA will never even know. 

What to do about an RRSP Over-Contribution

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