Last week it was widely reported by several media outlets that thousands of Canadians have once again broken the TFSA rules. More specifically, they have breached the over-contribution rules. Dean Beeby of the Canadian Press notes in this
that the Canada Revenue Agency (“CRA”) sent out 76,000 letters (down from the 103,000 letters last year) informing Canadians they have over-contributed to their TFSAs and are subject to penalties of 1% per month on the excess over-contribution (The CRA may waive a penalty if they consider there to be a genuine misunderstanding and the over-contribution is removed within a reasonable period of time).
Generally, I believe blame should start and stop with yourself. However, where thousands of people are making the same mistake, it is obvious the CRA and the institutions administering TFSAs are still not enunciating and communicating the rules clearly to Canadians, despite their good intentions in some cases.
In general, there are two ways over-contributions arise in a TFSA:
1. Individuals contribute an amount greater than their yearly contribution limit.
As described in this CRA
, your yearly TFSA contribution room is made up of the following:
- your TFSA dollar limit ($5,000 per year plus indexation, if applicable);
- any unused TFSA contribution room from the previous year; and
- any withdrawals made from the TFSA in the previous year, excluding qualifying transfers or specified distributions.
2. Withdrawn TFSA contributions are “put back” in the wrong year
As described in this CRA
, TFSA withdrawals can only be returned to your TFSA in the year after you have made a TFSA withdrawal. This is because in the contribution room formula noted above, your contribution room increases for any withdrawals made only in the
previous year, not the current year
For example: if you withdrew $3,000 from your TFSA in February, 2012 and you put back any portion of that $3,000 (assuming you have no other contribution room) at anytime in 2012, you will have over contributed in 2012. The over-contribution results because the $3,000 withdrawal should not be added to your contribution room until 2013.
So, after several years of thousands of Canadians misunderstanding the withdrawal rules for TFSAs, why doesn’t the CRA request, or financial institutions on their own volition, take the simple step of requiring its representatives to ask the following two questions before a TFSA contribution is accepted?
1. Have you confirmed your yearly TFSA contribution room to your income tax assessment or with the CRA through your online account or any other means?
2. Does your contribution include an amount put back on account of funds withdrawn during the current calendar year? If so, do you understand the current year withdrawal does not increase your contribution room until next year and unless you have other contribution room, you will have an over-contribution subject to penalties?
I would suggest that if these two simple common sense questions were mandatory questions financial institutions asked its customers before they made TFSA contributions, the CRA would have no need for 76,000 letters next year and taxpayers would have no one to blame, but themselves.