Understanding the overcontribution rules

Individuals are considered to have exceeded their RRSP contribution room if their unused contributions from prior years, together with their current year contributions, are more than the RRSP deduction limit shown on their latest notice of assessment. This amount does not include the allowable $2,000 overcontribution.

Clients who choose to make the $2,000 overcontribution can benefit from the tax-deferred growth of this amount in their RRSP until they choose to withdraw it, usually when they convert their RRSP to a registered retirement income fund or some other financial product at age 71.

Henry Korenblum, manager of tax with Crowe Soberman LLP in Toronto, suggests that the earlier a client overcontributes, the longer they can benefit from the overcontribution’s tax-deferred growth. This period can be as long as 40 years, he notes, although he does not recommend overcontributing as a deliberate tax planning strategy.

Instead, adds Doug Carroll, vice president, tax and estate planning, with Invesco Canada Ltd. in Toronto, clients “should leave the overcontribution room in the background as a safety valve” to prevent paying penalties if they do overcontribute at some point.

When your client withdraws the overcontribution, it must be included as income on his or her current year’s tax return. However, your client may be able to claim a deduction for the overcontribution by using CRA Form T746: Calculating Your Deduction for Refund of Unused RRSP Contributions.

However, if your client overcontributes by more than $2,000, a 1% penalty tax will be applied for each month the excess contribution remains in the RRSP, advises Korenblum. Your client also will have to complete a Form T1-OVP: Individual Tax Return for RRSP Excess Contributions to calculate the amount of the overcontribution and penalty taxes. This form must be filed, and the taxes remitted, within 90 days from the end of the year in which the overcontribution was made.

Korenblum adds: “Such a taxpayer is liable for interest and penalties for either not filing the T1-OVP or for filing the form late.” That penalty is 5% of the balance owing, plus 1% of the balance owing for each month that the return is late, to a maximum of 12 months. Plus, if your client has a balance owing, compound daily interest will be charged starting on the 91st day of the following year on any unpaid amounts owing for that year.

Carroll advises that if your client makes such an overcontribution (beyond the $2,000 that is permitted), relief can be sought to waive the taxes on the overcontribution if the excess contribution amount arose because of a reasonable error and in cases in which your client can show that reasonable steps are being taken to eliminate the excess contribution.

If your client believes an overcontribution was made, he or she should withdraw the excess amount as soon as possible. The withdrawal must be included in the client’s income but an offsetting deduction may be claimed, subject to two conditions: your client reasonably expected to claim a deduction for the contribution, either in the year it was made or in the year before; and, he or she did not make the contribution with the intention of later withdrawing it and deducting the offsetting amount.

Prior to withdrawing the overcontribution, your client can request that the CRA certify the amount to be withdrawn by using Form T3012A: Tax Deduction Waiver on the Refund of Your Unused RRSP Contributions. This certified form will allow the financial institution holding your client’s RRSP to release the associated monies without withholding taxes.

If your client withdraws the excess contribution without submitting a T3012A, the financial institution will withhold taxes on the amount, which your client then will have to reclaim.

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