An oc can be ok — and even advisable. OC refers to a deliberate RRSP overcontribution. Normally, overcontributions carry a stiff penalty of 1% per month. But the rules permit planholders to overcontribute by as much as $2,000 penalty-free.

This cushion — first set at $8,000 but then slashed to $2,000 in 1995 — was meant to protect pension plan members who put in too much by accident. But it’s open to everyone, creating several ways to pad an RRSP.

First, some basics:

Everybody who was 18 or older on Jan. 1 gets the $2,000 cushion — even if they lack the income required to generate RRSP contribution room.

Overcontributions are made with after-tax money; there is no up-front tax deduction as with a normal contribution. This money will then face taxation a second time when withdrawn from the RRSP, although that can be avoided.

The $2,000 is often described as a “lifetime” limit. It’s actually an “any time” limit. A client can do a $2,000 OC now and later count it as part of his or her normal RRSP limit in lieu of a new cash contribution. That makes the money tax-deductible and resets the
available cushion at $2,000.

The Canada Revenue Agency tracks overcontributions and reports the tally in the notice of assessment it issues after processing a taxpayer’s annual tax return. Look for “unused RRSP contributions” at the bottom of the RRSP Deduction Limit Statement.

The accompanying chart shows how much a one-time deposit of $2,000 can add to a plan’s accumulation. Suppose the money sits for 20 years. The $2,000 would more than double to $5,307 at a 5% compound annual growth rate, and almost quintuple to $9,322 if it averages an 8% CAGR.

Here are five OC strategies. Remember, though, that the penalty-free zone is $2,000 per person, not per strategy nor RRSP account.

> The advance contribution. Your client simply makes an overcontribution and lets it ride until a future year when he or she will use Schedule 7 of the T1 tax return to count it as part or all of the normal contribution in lieu of cash. The $2,000 then becomes tax-deductible, enabling your client to avoid the second tax bite mentioned above while benefiting from years — possibly even decades — of tax-sheltered compounding. In effect, your client can make $2,000 of his or her 2020 or 2030 contribution now.

Your client can also consider converting the OC to a regular contribution in the first year of full-time retirement. The client will have RRSP contribution room based on the previous year’s income but may be short of cash while adjusting to his or her new life.
This would generate a tax deduction without any monetary outlay.

> The offspring jump-start. This is a variation of the advance contribution. Your client’s children each get a $2,000 OC cushion after they turn 18, even if they don’t have RRSP-eligible income. Your client could give each one up to $2,000 to start an RRSP. The child can apply that against his or her own normal tax-deductible limit in the future or let it ride until retirement. Meanwhile, the money is available for the Homebuyers’ Plan and Lifelong Learning Plan by the child.

> The spousal accelerator. Spousal RRSP contributions must normally sit for two years from the end of the year in which the contribution is made. That often creates a three-year holding period. Withdrawals during that time are taxable for the contributor, not the receiver.

Let’s say your client’s normal RRSP limit is $2,000 and it gets used for spousal contributions. Instead of putting just $2,000 into the spousal plan this year, the client can put in $2,000, plus $2,000 of unused OC room for a total of $4,000. The client then claims a $2,000 tax deduction for this year and generates another $2,000 deduction next year by counting the OC as his or her normal 2006 contribution. This gets money into the mate’s plan sooner and cuts the holding period on the second $2,000 by one year.
Remember that the holding period is based on the year the contribution is made, not the year for which the deduction is claimed.

> The $600 two-step. RRSP contribution limits for pension plan members are reduced by the deemed value of their pension credits — the “pension adjustment.” PAs for generous plans are often so high that the individual gets only the basic RRSP limit of $600. That’s below the minimum purchase for many investment funds and can be a nuisance for individuals and their advisors.

@page_break@Jim, a civil servant, is in this situation. He plans to forgo RRSP contributions until his unused room builds to a worthwhile level. But will he have the cash when that time comes?

Jim could instead contribute $2,600 for this year — $600 in tax-deductible 2005 room plus the non-deductible $2,000 OC. That gets the money working inside his plan. Then the two-step starts.

Step 1: Jim makes no contribution for 2006 but uses Schedule 7 to apply $600 of the OC previously made. This turns $600 of OC into a normal RRSP contribution, creates a $600 tax deduction for 2006, and frees up $600 of OC cushion.

Step 2: Jim puts $1,200 into his RRSP for 2007 — $600 in normal tax-deductible room and a $600 overcontribution using the cushion he freed up in 2006.

In 2008, Jim starts a new cycle by doing Step 1; this dance generates a tax deduction every year and enables him to invest more than $1,000 every other year.

> The executor’s top-up. If a person dies with available RRSP contribution room, the will’s executors can top up the deceased’s plan. The executor can also overcontribute if there’s room within the $2,000 limit. This would boost the RRSP balance that can be rolled to the surviving spouse’s RRSP or RRIF, but would pay only if the spouse is likely to live long enough to overcome the tax bite when that money is withdrawn. It’s probably more worthwhile if the RRSP beneficiary is a child who is very young or disabled. The will should explicitly authorize such transfers to prevent other heirs from challenging them. Executors can also apply an outstanding OC to the unused RRSP room, creating a tax deduction for the estate without moving any cash. IE

Bruce Cohen is co-author of The Pension Puzzle (John Wiley & Sons Canada, 2004).