Every year, taxpayers enjoy the unique opportunities of their tax-advantaged accounts. Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP) create opportunities for taxpayers to save and invest in unique ways while enjoying a tax benefit. However, every financial tool has a specific set of rules and limits.
Understanding the rules and limits is important to leverage these tools correctly and avoid costly mistakes. In this blog post, we’ll explore the contribution limits of an RRSP and TFSA account, what to do if you’ve over-contributed to your accounts, the consequences of over-contributing, and how to avoid over-contributing to your accounts in the future.
How Do you Know if You Over-Contributed to Your RRSP?
Each taxpayer is advised of their RRSP contribution room on their Notice of Assessment each year. If you’ve over-contributed, you’ll find the details there as well.
It’s important to understand how your RRSP entitlement is calculated in order to know whether or not you’ve over-contributed. The Canada Revenue Agency calculates your unused RRSP deduction room based on various factors and adjustments.
In its simplest form, your contribution room is calculated based on your unused deduction room at the end of the preceding year plus the lesser of either 18% of your earned income in the previous year or the annual RRSP limit (the 2022 limit was $29,210).
How Do You Know if You Over-Contributed to Your TFSA?
Your annual TFSA dollar limit differs from your RRSP in that every taxpayer (aged 18 years or older) receives the same yearly entitlement. The unused contribution room is carried forward to future years.
Your contribution room is therefore calculated as the TFSA dollar limit of the current year plus any unused contribution room from previous years plus any withdrawals made from your TFSA in the previous year. The total annual TFSA dollar limit for 2023 is $6,500.00.
To confirm your current contribution room, sign in to your CRA Account or call the Tax Information Phone Service at 1-800-267-6999, as the amounts are no longer included on your Notice of Assessment.
What Happens When You Over-Contribute to Your RRSP or TFSA?
If you over-contribute to your RRSP or TFSA, you may be liable to pay a penalty or tax.
For RRSP accounts, the CRA allows a buffer for error. If you over-contribute to your RRSP account by more than $2,000, you must pay a 1 percent per month tax on your over-contributed amount until it is removed or the CRA waives the penalty. You will not receive a tax deduction for the extra $2,000, but you won't have to pay tax on that amount.
The CRA does not have the same $2,000 threshold for your TFSA account. If you contribute more than your available TFSA contribution room, you will have to pay a tax equal to 1 percent on the excess amount per month until the amount is removed.
What Can You Do if You’ve Over-Contributed to Your RRSP?
If you know you've over-contributed to your RRSP, it's best to deal with it immediately to avoid further penalty and tax. To remedy the situation, you will need to withdraw the amount as soon as possible.
You can ask the CRA in writing to consider cancelling or waiving the tax if two conditions are met:
The excess contributions is due to a reasonable error; and
You are taking or have taken reasonable steps to eliminate the excess contributions.
To apply to have the CRA waive the tax on excess contributions, you or your tax preparer must file a RC2503, Request for Waiver or Cancellation Form, which will include correspondence that you’ve met the conditions above.
If you’re subject to a penalty based on over-contributing to your RRSP, you must file a T1-OVP Form within 90 days of the end of the calendar year to avoid late fees.
What Can You Do if You’ve Over-Contributed to Your TFSA?
If you've over-contributed to your TFSA, the best remedy is to remove the over-contributed amount as soon as possible. The CRA does not allow a $2,000 buffer as it does with RRSP accounts; therefore, it is essential to track your contribution room. For further information regarding your TFSA, speak to a professional or refer to CRA's TFSA Guide for Individuals.
How Can You Avoid Over-Contributions?
Over-contributions can occur easily, especially if you have multiple investment accounts held with different financial institutions. To avoid over-contributing to your TFSA and RRSP, consider the following:
1. Monitoring and Tracking
As with anything, it’s important to understand your contribution room and track your contributions throughout the year. This will negate any surprises come tax time. The CRA has created a tracking worksheet (RC343) to specifically assist with monitoring the TFSA contribution room.
2. Utilize Both RRSPs and TFSAs
Often, taxpayers only utilize one account based on their goals. For example, individuals may want quick access to their money, so they may not want to use an RRSP for their savings. If your financial situation permits, utilizing both an RRSP and a TFSA account will give you tax advantages and assist with excess contributions.
3. Seek Professional Guidance
Hiring a professional who understands your situation and can monitor your contribution room and deposits can assist with avoiding costly mistakes due to over-contributions.
Stay Informed and Avoid Excess Contributions
Although over-contributing to your TFSA and RRSP accounts may seem like a minor oversight, it can lead to costly taxes and penalties come tax time. Staying informed with respect to your contribution room will be the easiest way to avoid surprises come tax time. Hiring a professional and dealing with any excess contributions as soon as possible is the way to a secure and prosperous financial future. If you're looking for a professional to provide insight into your specific situation, contact us today!