During RRSP season, people get anxious about a variety of issues: Where to
find the cash to contribute is one, missing the March 1 deadline is another.
And, oh, horror! What if you've over-contributed to your RRSP?
Under the Income Tax Act, you are allowed to overcontribute -- but not deduct
-- up to $2,000 more than your RRSP contribution limit for the year without
penalty. Your RRSP contribution limit is essentially 18% of your prior year's
earned income (up to a maximum of $16,500 for 2005), minus any pension
adjustment, plus any unused room from prior years.
The penalty for overcontributions is severe: You pay 1% per month on any
amount overcontributed beyond the $2,000 buffer.
However, it's important to ascertain whether an overcontribution has really
occurred. On Jan. 1, 2006, new contribution room opened up with respect to your
2005 earned income.
Take the example of Joel, whose RRSP contribution limit for 2005 is $16,500.
Having forgotten that he made an early 2005 contribution last year, Joel
accidentally contributed the entire additional $16,500 to his RRSP.
Assuming that Joel earned $100,000 in 2005, his RRSP-contribution limit for
2006 will be $18,000 (the new maximum dollar limit for 2006). Thus, he will not
be in an overcontribution position.
One of the most common reasons for overcontributing to a RRSP stems from
belonging to a group RRSP program through an employer. Typically, an employer
makes matching RRSP contributions on the employees' behalf. The employee, trying
to maximize his contribution, miscalculates and ends up overcontributing.
The fastest, easiest way to correct an overcontribution situation is to
simply request a withdrawal of the amount overcontributed from the RRSP issuer.
This amount will be subject to withholding tax, which can be recovered later
when you file your 2006 tax return. You will need to include a copy of the
Canada Revenue Agency's Form T746 entitled Calculating Your Deduction for Refund
of Undeducted RRSP Contributions.
Alternatively, to avoid the withholding tax and the associated costs of not
having that money invested on your behalf for more than a year, you can use
CRA's Form T3012A, Tax Deduction Waiver on a Refund of Your Undeducted RRSP
Contributions. After completing parts one and two of this form, you mail it in
to your tax centre, where it will be reviewed by the CRA and returned to you.
You then complete the remainder of the form and submit it to the RRSP issuer to
withdraw the overcontributed amount without being subject to the withholding
tax.
This process can take some time during which the monthly penalty tax is
accruing. So it may make sense in some cases to bypass the T3012A process and
simply withdraw the overcontribution, pay the withholding tax, and get that back
when you file your tax return.
As a result of a tax case decided two years ago, the RRSP withdrawal need not
come from the same RRSP into which the overcontribution was made, but from any
RRSP in your name. This is helpful as there may be a fee or commission for
disposing of an asset inside the RRSP, so you may wish to withdraw the
overcontribution from another plan with more liquid assets.