What Happens When You Contribute Excess Amounts to your RRSP

Being able to contribute to an RRSP is one of the great tax saving strategies available to all Individual Canadian Taxpayers who generate “earned income” which is essentially income earned from employment (salaries) or self employment,  (Passive income like dividends and interest is ineligible for consideration when calculating how much you can contribute to an RRSP).  There are .unfortunately limits to how much you can contribute and Revenue Canada (CRA) actually imposes penalties on overcontributions to your RRSP.

RRSP contribution room is based on earned income from the prior calendar year, (subject to certain adjustments), multiplied by 18% up to a maximum amount, which changes every year ($22,970 for 2012).  For example, if you earned $40,000 from employment in 2011 you will be able to contribute and deduct up to $7,200 from on your 2012 tax return.   If you do not contribute the full $7,200 in 2012 you are permitted to carry any unused amounts forward and add it to the amount that you can contribute in the following year.  These carryforward amounts can be very useful particularly when your income is lower in earlier years and you can’t afford to contribute much (although it is always good to contribute at least a little) as you can offset unused deductions against your income as it increases.

So why is there a problem with excess contributions?  RRSP contributions allow taxpayers to reduce their tax liability by saving for retirement.  Both contributions and income earned on contributions accumulate tax free until the time comes to withdraw funds for retirement (or other urgent needs prior to retirement).  Excess contributions are also earning income on a tax free basis instead of being taxed.

The penalties for excess contributions are quite steep at 1% per month of the excess contribution.  This amount, along with your RRSP contribution room, is indicated on your notice of assessment for the tax year.  The government allows for $2,000 in addition to your current contribution room.  Any contributions in excess will be subject to the 1% per month penalty.

If in fact you have over contributed you are required to fill out form T1-OVP to determine the amount of tax that you owe.  If you do not fill out the form and the pay the appropriate tax, you will be charged a penalty on top of the tax as follows:

If you owe tax in a year and do not file your return within 90 days after the end of that year, we will charge you a late-filing penalty. The penalty is 5% of your balance owing, plus 1% of your balance owing for each month that your return is late, to a maximum of12 months.

While many of us don’t really consider that there are actually consequences to over contributions, figuring that we can just carry them forward to next year, the onus is on the taxpayer to know their contribution limits.  As such, prior to making contributions it is important to consult your notice of assessment for the prior year, consult your personal tax file online or contact Revenue Canada by phone to ensure that you know exactly how much you can contribute.