A Registered Retirement Savings Plan (RRSP) is one of the best ways to save for retirement. It offers so many long- and short-term benefits. However, it’s important to understand exactly how much contribution room you have in any given year. Why? When you over-contribute, you pay a penalty. No one wants that. But the good news is that you can fix RRSP over-contributions.
In this article, find out how to fix over-contributions, and get answers to some of the most commonly asked questions about RRSPs. For example: What exactly is an RRSP? How do you know how much to invest, and where? Do you even really understand what an RRSP is and what it’s used for? And what happens if you over-contribute to an RRSP?
What is an RRSP?
An RRSP is a savings account designed to help Canadians save money for retirement. Contributions to RRSPs are protected from income tax. And they come in many different types of investments. In addition, any funds earned through these investments are protected from tax for as long as they remain invested. Therefore, this helps grow your portfolio in time to retire comfortably.
However, to maximize this benefit — and avoid the personal hassle of having to fix over-contributions — it’s important not to over-contribute to an RRSP. Otherwise, you have to either fix it or pay a penalty.
The Benefits of Making RRSP Contributions
The best advice is to invest in RRSPs as early and as soon as possible. And that’s because it ensures a comfortable retirement. But there are other, short-term benefits as well — as long as you don’t over-contribute, of course.
Your investments in an RRSP-sheltered product are untaxed. Therefore, at income tax time, you lower your income by the amount of total contributions to your RRSP. And this ultimately lowers the amount of tax you owe to the government for that tax year. Of course, income tax is paid when you withdraw the money. But if you don’t need to access it until you retire, then don’t. Because income is traditionally lower in retirement. And lower income means a smaller tax hit on withdrawals.
How Do Contributions to an RRSP Work?
You invest in RRSPs throughout the course of your working life. The government sets annual contribution limits, (and it’s important to pay attention to those limits so you don’t have to fix over-contributions). But the intention is to leave that money alone until retirement, when you’re making less, or no, money. This is also when you likely have fewer expenses.
And the money that goes into an RRSP is tax-deferred. So it lowers your taxes when you make more money. In addition, when you eventually withdraw from it in retirement, you are charged a lower tax rate because you’re making less. And that means you keep more of the money you earn in your own pocket and out of the government’s hands.
How Much Can I Contribute to an RRSP?
Maximum RRSP Contribution Limit For 2019 And 2020
The first step to ensuring you don’t over-contribute to an RRSP is to understand your maximum RRSP contribution limit. The maximum amount you contribute in any given year changes based on current government regulations and your previous year’s earnings and contributions. You may also carry over the contribution room from previous years. But again, it’s important to know this number so you don’t have to fix over-contributions down the road.
For the 2019 tax year, your RRSP contribution limit is 18% of the reported income on your 2018 tax return. And this is up to a maximum of $26,500. In 2020, that maximum increases to $27,230. So make sure you don’t exceed your RRSP contribution limits.
Avoid having to fix over-contributions to your RRSP by estimating your limit with the help of an RRSP calculator.
How Can I Make Sure I Don’t Over-Contribute to My RRSP?
It’s important to understand your RRSP contribution limit to make sure you don’t over-contribute. And while there are ways to fix an over-contribution to an RRSP, it’s a better strategy to first try to figure out your personal contribution limit. And there are a number of ways to do that.
How to find your own personal RRSP contribution limit:
- On line A of your previous year’s Notice of Assessment (NOA)
- Log into your CRA My Account
- Call the CRA’s Tax Information Phone Service (TIPS)
- On Form T1028, which you receive when your RRSP deduction limit changes from your last assessment.
What Is The Deadline For RRSP Contributions?
To get the maximum benefit from your RRSP contributions — and to avoid having to fix over-contributions — it’s important to take note of the deadline for RRSP contributions. It is Mar. 1 of the next calendar year. So for example, for 2019, you can contribute until Mar. 1, 2020. Contributions made during the calendar year go into your tax form differently than those made between Jan. 1 and Mar. 1. However, it is all applied towards RRSP contributions for the previous tax year. To clarify, next year’s RRSP deadline is Mar. 1, 2020.
What Happens If I Over-Contribute to an RRSP?
With RRSPs, you can exceed your contribution limit by $2,000 without penalty. However, after that, you no longer benefit from any further tax deduction. In addition, you pay a 1% penalty tax for every month you are over your limit. Instead, withdraw the money and wait until the next tax year to benefit from that contribution.
It’s great that you have extra money to invest. But you want to avoid over-contributing to an RRSP. Because while you can fix over-contributions to an RRSP, you want to avoid a situation where you have to scramble to make a change.
How Do I Determine If I Have Over-Contributed To An RRSP?
To check where you have over-contributed to an RRSP, log into your CRA account and click on your Notice of Assessment (NOA). If you over-contribute, there is a tax on excess contributions. To determine the exact amount of your over-contribution, look at your NOA from the previous year and review your contribution limit. Review your contribution from the current tax year and deduct your limit. And the difference is your RRSP over-contribution.
How To Fix RRSP Over-Contributions
One way to fix over-contributions is to remove the funds as quickly as possible and place them in a Tax-Free Savings Account (TFSA). That way, the money still has the potential to work for you and earn money. And at the same time, it’s still not easily accessible. However, there are other ways you can fix an over-contribution.
Three Ways to Fix RRSP Over-Contributions
- Withdraw the amount — Once you take out the amount of overpayment, request the government refund your penalty. In order to do this, contact the CRA and prove you removed money and reassigned to another savings tool. In addition, you need to prove the overpayment was unintended, and therefore you can’t be held liable for the penalty implication.
- Pay the penalty — This sounds simple. However, it actually involves a little legwork on your behalf. To pay the penalty, go back into your CRA My Account portal and review your recent NOA. This helps determine your actual overpayment. Review your allowance from the year previous. Fill out a T1-OVP, Individual Tax Return for RRSP, PRPP and SPP Excess Contributions form and pay the 1% tax penalty.
- Prove you have the contribution room — The CRA allows you to carry over unused contribution room from previous years. So, if you do not take full advantage of your RRSP contribution allowance, provide that evidence to the CRA. And show that your allowance is greater than the limit indicated on NOA from the previous tax year.
RRSPs and Over-Contributions
RRSPs are a powerful retirement savings tool. However, it’s important to understand how much you can contribute in any given year. It’s the best way to ensure you don’t get dinged for an RRSP overpayment. And while there are ways to fix over-contributions to an RRSP, it’s best to avoid it happening in the first place. But if it does, it is not the end of the world. Speak to your financial advisor to manage the overpayment.