One of the basic rules to maximize the value of an RRSP is to contribute as much as possible as soon as possible. This allows the maximum capital to appreciate tax free for as long as possible, resulting in the maximum value in the RRSP. Of course, the taxman isn’t willing to let you contribute as much as you want, so there are limits. The amount you can contribute and deduct in 2009 to your RRSP is 18% of your earned income for 2008, up to a maximum of $21,000. Any unused contribution room of prior years after 1990 can also be used in 2009.
The strategy to maximize your RRSP then becomes to contribute the maximum amount every year, as soon as possible. If making a lump sum contribution, it should have been made immediately after the 2008 contribution period, that being on March 3, 2009, rather than waiting until the last moment, March 1, 2010. Contributing early would have meant that an entire year of growth would have been earned tax free. Contributing early means that you will have to wait for a year to claim the tax deduction for the RRSP contribution, however, the net gain to the RRSP will often exceed the cost of early contribution. Your accountant can provide guidance on this trade off.
One problem with making an early contribution is that your 2008 tax return may not have been assessed, so you might not have been sure of the exact amount of the 2009 contribution room available. Rather than making a smaller contribution to make sure you don’t exceed the contribution limit, the Income Tax Act allows for a $2,000 cushion on RRSP contributions. As long as you don’t exceed a $2,000 overcontribution, you will not be penalized if you contribute too much to your RRSP.
The tax free growth of the RRSP is so attractive that the tax department pays attention to overcontributions, and requires that a penalty be paid on overcontributions exceeding the $2,000 limit. The penalty is 1% of the overcontributed amount for every month that overcontribution remains in the RRSP. This amounts to 12% per year, plus interest. Any investment inside the RRSP would have to earnpretty spectacular returns to be able to make it worthwhile to pay the penalty and interest.
When you file your income tax return, you have to report all of your RRSP contributions. At that time you can choose to deduct any amount up to your contribution limit. Any amount you do not deduct is shown as a carryforward amount on your notice of assessment. If the RRSP carryforward amount is more than $2,000, your notice of assessment will state that you may be required to file a T1 OVP form to calculate any penalty you may owe. Canada Revenue Agency regularly reviews RRSP contributions and will request that you file a T1 OVP form if you appear to have overcontributed to your RRSP.
If you know that you have contributed too much to your RRSP, talk to your accountant right away. If you are subject to penalty, you need to determine how much needs to be pulled out of your RRSP to stop accruing penalties every month. You can’t just cash-out part of your RRSP, you need to file a special form called a T3012A to request a refund of unused RRSP contributions. You file this form with CRA, who then returns the form once approved. You then take the approved form to your financial institution to obtain the refund.
If you think you overcontributed to your RRSP, talk to your accountant right away. The rules are complex and the longer you leave the overcontributed amount in your RRSP the higher the penalty may be.