Banka: Little known facts about RRSPs and their expiry

RRSPs were developed to create a personal tax deduction in the current year and defer taxes on the amount until a future year when it is assumed that the taxable income will be lower.

For example if a person made $105,000 which attracts 40.70 per cent combined federal and provincial tax (at 2013 rates), that person could take out enough of an RRSP to reduce their combined federal and provincial taxable income to the next lowest tax bracket of 38.29 per cent, saving themselves 2.41 per cent or more of tax in the current year.

They would need to take out at least $5,000 in an RRSP and would have saved about $120.50 in taxes.  Then in a later year if the $5,000 was withdrawn and the total taxable income was less than $36,000, then tax on that $5,000 would be at 20.06 per cent instead of the 40.70 per cent (providing that the personal tax rates remain the same) which is an overall tax savings of 23.05 per cent.

In order to stop people from contributing exorbitant amounts to RRSPs to save taxes, an annual deduction limit was introduced.  This limit is a complicated calculation but for the most part works out to be approx 18 per cent of your qualifying annual earned income and is cumulative in that if you didn’t contribute to an RRSP in one year, you can still use that contribution room in a following year.

On your notice of assessment, usually at the bottom of page two, is where you can find the details of your RRSP deduction limit.  It is important to note that line (A) is the maximum that you can deduct.  Sometimes there is an amount in line (B) which means that you have overcontributed to your RRSP but have not deducted the amount from your taxes because it was over the deduction limit, or an adjustment might have been done to your tax return resulting in reducing the deduction limit.  Many people misread this line and think that they can contribute this amount to their RRSP and end up with a growing overcontribution amount until someone realizes what has happened.

When you turn 71 you will be required to roll your RRSP into a RRIF and at this time you stop collecting deduction room and your deduction limit may even be $0.  Now if you have overcontributed you have approximately two years to be able to take advantage of the overcontribution on your tax return.

If you don’t take advantage within those two years and don’t have any deduction room, you may lose the benefit of that tax deduction.  What happens in effect is that you didn’t get the tax deduction when you made the original contribution and then when you are withdrawing out of your RRIF you are taxed on that, so you end up paying double the tax.

Not only that, if you have overcontributed by more than $2,000 you could be subject to interest on the amount you overcontributed.

The tax on overcontributions is one per cent per month on the amount that exceeds the $2,000.  There is an exception to this if the overcontribution occurred between 1991 and February 26 of 1995 when the excess limit was $8,000 and as long as you never contributed after that, then the old rules kick in and you may not need to pay the interest.

So, you need to take a look at your Notice of Assessment and find the Deduction Limit Statement and check to make sure that there is no balance in line (B).  If there is, and you have contribution room you can contact the institution that manages your RRSP and take that money out.  They will automatically deduct a minimum of 10 per cent tax from the amount and issue you a T4RSP slip which will then be offset by this overcontribution amount on your tax return and you end up not paying any tax on that withdrawal.

Another alternative is to have the institution fill out form T3012A which will allow you to withdraw the amount without having the tax withheld at source.

Alternatively, after the two year window and if your RRSP has been rolled into a RRIF, you can fill out form T746 Calculating Your Deduction for Refund of Unused RRSP Contributions to have any excess contributions taken as a deduction up to the limit shown in Box 20 or 22 of the T4RSP slip or box 24 of the T4RIF slip.

Make sure that you bring this to your accountants’ attention when you are filing your next tax return.  You may even be able to submit a T1 Adjustment for the taxes just filed.

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