How to fix an RRSP or TFSA over-contribution
Putting too much cash in your RRSP or TFSA is an easy mistake to make. Here’s how it can happen, and how to deal with it.
It can be all too easy to accidentally exceed the contribution limit for your registered retirement savings plan (RRSP), especially if you’re rushing to get your contribution in before the deadline.
It’s also not hard to put too much in your tax-free savings account (TFSA) . If you make either error, don’t panic: There are simple ways to address a TFSA/RRSP over-contribution while also ensuring you are taking full advantage of these powerful savings vehicles.
RRSP over-contributions: How they happen
Each year you can contribute as much as 18% of the income you earned in the previous tax year to your RRSP, up to an annual maximum, plus any unused contribution room carried forward from previous years.
That can be quite a lot of money. So how do people end up exceeding these limits?
“Over-contributing is easy to do if you’re in a group RRSP, for example,” says Bruce Ball, a vice-president at Chartered Professional Accountants Canada, “or you’re making automatic contributions.” Having a performance bonus deposited straight into your group RRSP is another way to risk contributing too much.
If you have a registered pension plan, don’t forget to account for the pension adjustment (PA) – that is, the value of contributions to the pension you make or your employer makes for you. Every dollar in the PA lowers your RRSP contribution room by the same amount.
While it’s useful to know the annual maximum contribution, the best way to find out how much you, personally, can put in your RRSP is to check the Notice of Assessment you received from the CRA after filing your previous year’s tax return. It lists your contribution limit for the current tax year, including information about your PA. You can also find this information on your CRA My Account page.
How RRSP over-contribution penalties add up
With an RRSP over-contribution, the CRA levies a monthly 1% “overage tax” on anything above a $2,000 “buffer” designed to protect you from small errors.
These overage taxes can add up fast, and the CRA may not alert you that you’ve exceeded your limit right away.
Let’s say, for example, you exceeded your 2018 RRSP limit by $8,000 in February. If you’d left the extra cash in until the calendar flipped to January 1, 2019, you’d pay 1% on $6,000 of your over-contribution — $660, or $60 per month times 11 months. And if you don’t pay the overage tax within 90 days of the end of the calendar year, you may be charged additional interest and penalties.
Keeping your TFSA on track
The TFSA penalty works the same way as its RRSP counterpart, except there’s no $2,000 buffer. You’re charged 1% monthly on your entire over-contribution.
It’s important, however, to note that unused room carries forward with TFSAs, too. In practice this means you could set up your first TFSA in 2019 with up to $63,500, so long as you were at least 18 years old – the minimum age to open a TFSA – when the accounts were first established in 2009.
Bottom line? It pays to stay aware of the annual TFSA contribution limit (which edged up to $6,000 for 2019). And while your RRSP limit is in part a percentage of your earned income, the TFSA limit is the same for everyone.
TFSA over-contributions: How they happen
TFSA rules stipulate that once you withdraw funds, you can’t recontribute them until the following year, unless you have enough contribution room in the current year to do so. That means that if you’ve already contributed the maximum allowed for this year and you take out $5,000 to use for a trip, then change your mind and put it back, you’ve over-contributed by $5,000. But if you’ve only put in $4,000 this year, you can put back up to $2,000 by year-end without penalty.
That said, the steady accumulation of contribution room since 2009 may mitigate this risk.
“Over-contributing was a bigger issue when TFSAs first started, because you only had a year or two of room [or $5,000 to $10,000],” says Ball. “So if you put in the full amount in year one or two, then made a withdrawal and put the cash back during the same year, you had a problem.” Today, assuming you haven’t contributed the maximum every year, you may have a bit of unused room that will cushion you from penalties.
Another potential pitfall: If you simply withdraw your TFSA funds, open a new TFSA elsewhere, and deposit the cash there, you could trigger a big over-contribution penalty. Remember that you don’t get the contribution room for that withdrawal back until the next calendar year, which means the entire deposit to your new TFSA would count as a fresh contribution in the current year.
If we’re talking about first withdrawing the TFSA maximum of $63,500 for 2019 and then recontributing it into a new TFSA, the entire amount would be penalized at 1% -- or $635 – for each month you’re over-contributed.
The safer way to move TFSA money is to have your current financial institution make a direct transfer for you.
How to fix an RRSP over-contribution
One option for addressing an over-contribution could be to do nothing. This may be a good approach to take if your over-contribution happened late in the year.
“With RRSPs and TFSAs, your over-contribution might disappear the next year, when you get more [contribution] room,” says Ball. “In that case, decide whether you want to deal with the hassle of taking the money out, especially if it isn’t a large amount.”
If you do remove the excess cash, be aware that there’s a time limit.
“You generally have to [withdraw the funds] in the year you over-contributed or the following year,” Ball explains. “It will be a regular RRSP withdrawal, so the CRA would charge you withholding tax when you take the funds out, and you’ll be out the tax until you file your return, though it is possible to ask the CRA to waive these withholdings through a T3012a form.”
You’ll be issued a T4RSP slip and also be required to fill out a T746 form when you do your tax return, in which you “lay out how much the over-contribution was and the amount you’re taking out as a refund of it, effectively.”
In this scenario, the over-contribution and withdrawal cancel each other out and you’ll be refunded any withholding tax.
How to fix a TFSA over-contribution
Withdrawing an excess contribution from your TFSA is easier because, unlike with RRSPs, your money isn’t taxed when you take it out of your account. You simply remove the cash from your TFSA, halting the penalty in its tracks.
A final option: Appeal for clemency.
For both RRSPs and TFSAs, the CRA may cancel all or part of the penalty under certain conditions, if you provide an explanation of what happened in writing.
Should you put your money in a TFSA or an RRSP?
Are you saving enough for your future? Try this RRSP calculator to find out.