How Do I Correct An RRSP Over-Contribution? How Do I Correct A TFSA Over-Contribution?

It’s Easier Than You Think — Here’s How!

It’s easy to put too much money in your RRSP or TFSA. Here’s why it happens and what to do about it. Accidentally going over the contribution limit for your registered retirement savings plan (RRSP) can happen quite easily, especially when you’re rushing to make your contribution before the deadline.

It’s also easy to exceed the limit in your tax-free savings account (TFSA). If you make either mistake, don’t worry. There are straightforward ways to fix an over-contribution to your TFSA or RRSP while still maximizing the benefits of these valuable savings tools.

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Over-contributions to RRSPs: Unveiling the Causes

Every year, you have the opportunity to contribute up to 18% of your income from the previous tax year to your RRSP, with an annual maximum limit. Additionally, you can include any unused contribution room carried forward from previous years.

This can amount to a substantial sum of money. How, then, do individuals find themselves surpassing these limits?

Exceeding the limit becomes simple, especially in scenarios like participating in a group RRSP or setting up automatic contributions. Depositing a performance bonus directly into your group RRSP is yet another way you might inadvertently contribute an excessive amount.

When dealing with a registered pension plan, it’s crucial to consider the pension adjustment (PA), which represents the value of contributions made either by you or your employer. Each dollar in the PA reduces your RRSP contribution room by an equivalent amount.

Although understanding the annual maximum contribution is helpful, the most accurate method to determine your individual RRSP limit is by reviewing the Notice of Assessment received from the CRA after filing your previous year’s tax return. This document outlines your contribution limit for the current tax year, incorporating details about your pension adjustment (PA). Additionally, you can access this information on your CRA My Account page.

Accruing Penalties: Understanding the Costs of RRSP Over-Contributions

When you exceed your RRSP contribution limit, the CRA imposes a monthly 1% “overage tax” on amounts surpassing a $2,000 “buffer” intended to safeguard against minor errors. These overage taxes can accumulate rapidly, and the CRA might not promptly notify you of your exceeded limit.

For instance, suppose you went over your 2022 RRSP limit by $8,000 in February. If you retained the excess funds until January 1, 2023, you’d incur a 1% charge on $6,000 of the over-contribution, totaling $660 ($60 per month for 11 months). Failing to settle the overage tax within 90 days after the calendar year’s end could lead to additional charges in the form of interest and penalties.

Ensuring the Success of Your TFSA

The TFSA penalty operates similarly to its RRSP counterpart but without a $2,000 buffer. It entails a monthly 1% charge on the entire over-contribution amount.

However, it’s crucial to recognize that unused room is carried forward with TFSAs. In practical terms, if you’ve always contributed the maximum amount into your TFSA, the most you can put in is $6,500 for 2023, and 2024 is going up to $7000. But if you never contributed before and turned 18 in 2009 or earlier, you may contribute up to $88,000 to the end of 2023. In 2024 the cumulative amount will be $95,000.

In summary, it’s financially beneficial to stay informed about the yearly TFSA contribution limit. Unlike the RRSP limit, which is determined by a percentage of your earned income, the TFSA limit remains uniform for everyone.

Unpacking the Reasons Behind TFSA Over-Contributions

TFSA regulations state that once you withdraw funds, you cannot recontribute them until the following year, unless you have sufficient contribution room in the current year. This implies that if you’ve already reached the maximum contribution for the current year and you withdraw $5,000 for a trip but decide to put it back into your TFSA, you’ve exceeded your contribution limit by $5,000. However, if your contributions for the year total only $4,000, you can put back up to $2,000 by the end of the year without incurring a penalty.

Nevertheless, the consistent accrual of the contribution room since 2009 may alleviate this risk.

Over-contributing posed a more significant challenge when TFSAs were initially introduced, as individuals had only a year or two of contribution room, ranging from $5,000 to $10,000. If you deposited the full amount in the first or second year, then withdrew and re-contributed the funds within the same year, complications arose. Today, assuming you haven’t maximized your contributions each year, there may be some unused room that acts as a buffer against penalties.

Another potential challenge arises if you withdraw your TFSA funds, open a new TFSA elsewhere, and deposit the cash there, as it may lead to a substantial over-contribution penalty. It’s crucial to remember that the contribution room for the withdrawal is only reinstated in the next calendar year. Consequently, the entire deposit into your new TFSA would be considered a new contribution for the current year.

If we consider withdrawing the TFSA maximum of $88,000 for 2023 and subsequently turning around and recontributing it to a new TFSA, the entire amount would incur a 1% penalty, equivalent to $880, for each month of over-contribution.

A better method for transferring TFSA funds is to arrange for your current financial institution to facilitate a direct transfer on your behalf.

What to Do If You Contribute Too Much To An RRSP:

If you’ve over-contributed and it’s late in the year, one option is to consider doing nothing. For RRSPs and TFSAs, the over-contribution might resolve itself the following year when you receive more contribution room. In such cases, consider whether it’s worth the hassle to withdraw the money, especially if it’s not a significant amount.

If you choose to withdraw the extra cash, be mindful that there is a time limit.

Typically, you need to withdraw the excess funds in the year you over-contributed or the subsequent year. This withdrawal is treated as a standard RRSP withdrawal, subject to withholding tax imposed by the CRA. You’ll be without the taxed amount until you file your return. However, it’s worth noting that you can request the CRA to waive these withholdings by using a T3012a form.

When you withdraw the excess funds, you will receive a T4RSP slip. Additionally, as part of your tax return process, you’ll need to complete a T746 form. This form requires you to detail the over-contribution amount and the portion you’re withdrawing as a refund, essentially clarifying the adjustment.

In this situation, the over-contribution and subsequent withdrawal offset each other, resulting in a refund of any withholding tax.

However, it’s advisable to consult with an accounting professional if you’re uncertain about how to correctly complete these forms.

What to Do If You Contribute Too Much To A TFSA:

Withdrawing an excess contribution from your TFSA is simpler because, unlike with RRSPs, your money isn’t taxed upon withdrawal. You can easily take the cash out of your TFSA, putting an end to any associated penalties.

Another possible course of action: Appeal for Clemency.

For both RRSPs and TFSAs, the CRA might waive all or a portion of the penalty under specific conditions if you submit a written explanation of the circumstances.

In conclusion, managing RRSP and TFSA contributions requires careful attention to limits and timely actions. Whether withdrawing excess funds, seeking leniency, or considering professional advice, staying proactive is crucial for financial well-being. Research also suggests that individuals with an investment advisor or portfolio manager tend to be less anxious, happier, and more confident, often resulting in a net worth up to three times higher than those who manage their investments independently. Ultimately, making informed choices and, when needed, seeking professional guidance can contribute to long-term financial success.

Have Questions? Contact us!

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Joe A. Macek, FMA, CIM, DMS, FCSI

Investment Advisor, Portfolio Manager

iA Private Wealth | iA Private Wealth USA

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