Tips so that you don’t go to court for contributing too much to your RRSP

Posted on by Duane Roberts

Taxes Personal Finances

Jamie Golombek: Here’s a refresher on RRSP deduction limits, some tools you can use to calculate potential tax savings for 2021, and a cautionary tale

Publication date:

Feb 17, 2022 • Feb 18, 2022 • Read 5 minutes • Join the conversation No matter how much you decide to contribute this RRSP season, it's important to stay within your contribution limit or pay a penalty tax of one percent per month for every dollar you contribute too much. No matter how much you decide to contribute this RRSP season, it’s important to stay within your contribution limit or pay a penalty tax of one percent per month for every dollar you contribute too much. Photo by Getty Images/iStockphoto

The deadline for the Registered Retirement Savings Plan (RRSP) is just two weeks away, so you may want to double-check your 2021 contribution limit to determine if you want to save a little more money before March 1.

This ad hasn’t loaded yet, but your article continues below.

To help you out, here’s a refresher on RRSP deduction limits, some tools you can use to calculate your potential 2021 tax savings, and a cautionary tale from the court where a taxpayer made a costly mistake in contributing to his RRSP on based on a misunderstanding of his contribution limit.

Your 2021 limit starts with your RRSP deduction limit from 2020, as unused room is automatically carried over from year to year. Then, before adding your new 2021 contribution allowance, any RRSP contributions you deducted on your 2020 tax return will be equal to 18 percent of your 2020 “earned income,” up to a maximum of $27,830. Earned income includes (self) employment income and rental income.

This ad hasn’t loaded yet, but your article continues below.

The 18 percent restriction is linked to something called the “factor of nine,” which uses a hypothetical defined benefit retirement plan, where by saving nine percent of an employee’s annual income, a person can purchase a retirement annuity that is equal to one percent of pre-retirement income. The Tax Act allows a participant in a defined benefit plan to accrue a tax-free annuity of a maximum of two percent of the final salary in the year of accrual, which would result in a pension of 70 percent of the pre-pension income over a 35-year career.

If you were a member of a retirement plan, you may have had a 2020 pension adjustment deducted (you cannot double your total savings) before reaching your 2021 RRSP deduction limit. But that’s not necessarily how much you can contribute, because in some cases you’ve chosen not to deduct previous RRSP contributions in a previous year. For example, if you contributed to an RRSP in 2020 while on parental leave and had little income, you may have decided to defer the deduction until the following year. In these situations, the non-deducted premiums reduce the amount you can contribute before 2021.

This ad hasn’t loaded yet, but your article continues below.

You can find your RRSP deduction limit by visiting the Canada Revenue Agency’s My Account service online or by referring to the RRSP deduction limit statement on your most recent (re)assessment notice.

You can find your RRSP deduction limit by going to the Canada Revenue Agency's My Account service online. You can find your RRSP deduction limit by going to the Canada Revenue Agency’s My Account service online. Photo by Peter J. Thompson/National Post

There are several online tools available to help you decide how much to contribute. Intuit Inc.’s TurboTax offers an RRSP optimizer that shows how much your tax refund could increase (or tax cut) by making an RRSP contribution. Enter your income, tax paid to date, and state and residence, and a slider allows you to play around with your RRSP contribution amount as your repayment (or liability) grows or shrinks. Accounting firm EY also has an RRSP calculator that shows what your RRSP contribution is worth in all 10 provinces and territories, based on your taxable income.

This ad hasn’t loaded yet, but your article continues below.

But no matter how much you decide to contribute this RRSP season, it’s important to stay within your contribution limit or you’ll face a penalty tax of one percent per month for every dollar you contribute too much (more than one allowable overshoot of $2,000). A recent tax case decided last month involved a taxpayer who was hit with the penalty tax for an erroneous RRSP overpayment that resulted from his misunderstanding of what “earned income” was.

In 2013, the taxpayer lost his job after 12 years of service with his employer. He was unhappy with the way he had been fired and hired a lawyer. With the help of his counsel, the taxpayer negotiated a severance payment of approximately $165,000. He received this amount in 2014 and included it in his taxable income. During the 2015 RRSP season, specifically in February of that year, the taxpayer paid an RRSP contribution of $24,270.

This ad hasn’t loaded yet, but your article continues below.

Fast-forward from three years to March 2018, and the CRA assessed the taxpayer an RRSP penalty tax of $1,106 with respect to the 2015 tax year. The penalty tax was only on a portion of his RRSP contribution, as he did have some room to contribute.

The case raised the question of whether his former employer’s benefit fell within the definition of earned income for the calculation of his available room. If that had been the case, there would have been no over-contribution.

The detailed claim method requires you to add up all the costs incurred and ensure that you have receipts and backup documentation for each claim.

Everything you need to know about declaring home office expenses on your tax return

CERB recipients who cannot verify their eligibility for the benefit must repay it.

What to do if the CRA starts asking questions about your CERB assistance?

The Canada Revenue Agency headquarters in Ottawa.

Why do we have to file a tax return at all?

A spousal RRSP is used when your spouse or partner has no (or minimal) income and therefore no contribution margin to make an own RRSP contribution.

Taxpayer tests RRSP contribution limits and gets on the wrong side of the CRA

This ad hasn’t loaded yet, but your article continues below.

The taxpayer maintained the payment as part of his wages from employment. After all, he would not have received the amount if he had not previously been employed by the payer. If the payment in question was not a reward and not an income from employment, he should not have been taxed on the payment at all, in his view.

This may have been the case before 1981, as previous case law concluded that such payments were not regarded as income from employment. But in late 1981, the definition of a “retirement benefit” was changed to include the full amount of any payment to an employee received as compensation or pursuant to a court decision. Under the current wording, a pension benefit is defined as an amount “received on or after retirement from a taxpayer from an … employment in recognition of the taxpayer’s long service, or in respect of the loss of office or employment of a taxpayer, whether or not received as, for the account or in lieu of payment of, damages or pursuant to an order or judgment of any court of competent jurisdiction.”

This ad hasn’t loaded yet, but your article continues below.

However, retirement benefits are taxable as “other income,” not as income from employment, and are therefore excluded from the earned income calculation that RRSP chamber sets. As a result, the taxpayer lost his case and he was stuck with the excess premium levy, which the judge reduced somewhat due to a calculation error by the CRA.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is the General Manager, Tax & Estate Planning at CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com

†

Sign up for the FP Investor newsletter for more stories like this.

†

This ad hasn’t loaded yet, but your article continues below.

By clicking the sign up button, you agree to receive the above newsletter from Postmedia Network Inc. receive. You can unsubscribe at any time by clicking the unsubscribe link at the bottom of our emails. Postmedia Network Inc. † 365 Bloor Street East, Toronto, Ontario, M4W 3L4 | 416-383-2300

Comments

Postmedia is committed to maintaining a lively yet civilized discussion forum and encourages all readers to share their thoughts on our articles. It can take up to an hour for comments to be moderated before appearing on the site. We ask that you keep your comments relevant and respectful. We’ve enabled email notifications – you’ll now receive an email when you get a reply to your comment, there’s an update to a comment thread you’re following, or a user follows comments. Visit our Community Guidelines for more information and details on how to adjust your email settings.

This post Tips so that you don’t go to court for contributing too much to your RRSP

was original published at “https://financialpost.com/personal-finance/taxes/tips-so-you-dont-end-up-in-tax-court-for-overcontributing-to-your-rrsp”

Related Posts