Confusion often results between the terms “RRSP deduction limit” and “unused RRSP contributions.” Both of these terms are used on the RRSP Deduction Limit Statement at the bottom of your Notice of Assessment from Revenue Canada.
Yesterday, our column dealt specifically with the term RRSP deduction limit. This column outlines how the unused RRSP contributions is integrated with RRSP deduction limit.
Most investors who contribute to an RRSP claim the deduction immediately on their tax return. Investors should understand that they do not have to claim the deduction immediately. In some cases it is recommended that you do not claim the deduction immediately. If you carry forward an amount it is referred to as “unused RRSP contributions.”
Why would you contribute to an RRSP and not claim the deduction immediately? The main reason is to shelter the income from tax. Once you have made the contribution into an RRSP all income generated within is deferred regardless if you have claimed the deduction. Two other main reasons why you may not claim a deduction immediately are the contribution exceeds current year taxable income, and future income is expected to be higher.
We have provided three illustrations below with different situations where a person may have unused RRSP contributions at the end of the year.
Mr. Bloomberg recently received a significant inheritance of $200,000 from his mother who passed away. Mr. Bloomberg came to see us and asked for our recommendations. Prior to our meeting we asked Mr. Bloomberg to gather some information together including his mortgage statement and 2006 tax Notice of Assessment. We noted that Mr. Bloomberg had $78,000 left on his mortgage with a very small penalty for prepayment. We recommended that Mr. Bloomberg repay this debt. Next we looked at his Notice of Assessment and noted that he had a $79,754 RRSP deduction limit. Mr. Bloomberg is earning approximately $58,000 per year, but over the years, he has not been maximizing his RRSP contributions. Mr. Bloomberg expects to work for at least another five years and believes that his income will increase over current levels.
Based on the information gathered we recommended that Mr. Bloomberg contribute $79,754 to his RRSP. Based on his current level of income Mr. Bloomberg should speak with his accountant and determine how much of this contribution he should claim in the current year and how much he should carry forward as unused RRSP contributions.
Mrs. Thomson recently became a widow at the age of 55. Her deceased husband had a life insurance policy with a death benefit of $250,000. Mrs. Thomson mentioned that she has no debt and approximately $77,300 in RRSP deduction limit. Mrs. Thomson is planning to work another ten years and has expected income during this period of approximately $50,000 a year.
We recommended that Mrs. Thomson shelter $77,300 from tax immediately. However, we also recommended that she claim the deduction over the next few working years. At the beginning of every year we would encourage Mrs. Thomson to roll some of the remaining non-registered funds to top up her RRSP. Based on $50,000 a year, she will have another $9,000 each year in additional RRSP room. She may also want to take advantage of the $2,000 excess contribution that CRA allows over the deduction limit.
Over the last 20 years Mr. Reuter has worked hard as a realtor. His knowledge and expertise has been in real estate and he has focused nearly all of his investments in that area. Mr. Reuter has never contributed to his RRSP and has an RRSP deduction limit of $143,600. Mr. Reuter is now in the process of selling one of his rental properties. We have estimated that his taxable capital gain on this property will be approximately $33,800 and the total proceeds will be approximately $389,000.
We explained to Mr. Reuter that contributions to an RRSP may offset the taxable capital gains. We also provided Mr. Reuter some information on alternative investments that he could focus on outside of real estate. We recommended that he could use a portion of the proceeds from the rental property and contribute $143,600 to his RRSP. He could deduct enough to reduce the capital gains tax and his real estate income in the current year. The remainder of the contribution he may carry forward as “unused RRSP contributions” to offset against future rental properties that he sells and his real estate commissions.
When you have an unused RRSP contribution amount it is important that you monitor this amount along with the RRSP deduction limit line. Be careful that the unused amount does not exceed your deduction limit by more than the $2,000 buffer that CRA allows.
If the unused amount exceeds the deduction limit amount by more than $2,000 then you have made what is referred to as an excess contribution. Excess contributions are subject to a one per cent tax on the excess amount for every month they are left in the RRSP. If you have excess contributions, you may have to complete and send a T1-OVP return with payment to your tax centre no later than 90 days after the end of the year in which the unused contributions exist. Failure to file this return may result in further interest and penalties. We would encourage all investors who have an excess contribution to proactively deal with their mistake before CRA sends you a letter.
Understanding RRSP terminology and your existing tax situation may ensure that you take full benefits of your options, including when to deduct your RRSP contributions.