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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

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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.

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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 return will be deducted, 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.

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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, as in some cases you may have 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.

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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.

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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.

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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.

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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 work, 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 current terms, old age 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.”

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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

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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”

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Author: Frederick Sullivan

Hannah Sullivan: As a seasoned journalist, Hannah's blog provides hard-hitting analysis and in-depth reporting on major crime stories. Her thorough coverage and fearless reporting make her a trusted voice in the field.