Why are so many Canadians Over-contributing to the TFSA

The Tax Free Savings Account (TFSA) was first introduced in 2009. My personal opinion is that the TFSA is one of the best financial tools devised in a long time. It allows for contributions and tax free growth and tax free growth and withdrawals. The TFSA can be a brilliant tool for short or long term investing.

Related article:  How to invest your TFSA

Unfortunately many people are not using the TFSA correctly and over-contributing triggering penalties applied by Canada Revenue Agency (CRA).  Why is this happening? First off, let’s look a little closer at what a TFSA is.

What is a TFSA?

A Tax Free Savings Account is a tax free account that enables us to put money away for any purpose. All the interest earned and income from investments grows tax free. It is a great tool for short term savings goals such as vacations or buying a car but it can also be a great addition to a person’s long term investment planning in coordination with RRSPs and other retirement investment products.

Related article:  Who will use the TFSA?

A person who is 18 years of age or older can contribute $5,500 to a TFSA this year. From 2009 to 2012 the amount was $5,000 per calendar year. In 2013 the amount was raised to $5,500 per calendar year and has remained there. Contributions are not based on your income level and if you don’t contribute the unused room gets carried forward.

Related article:  TFSA Basics: Contributions and Withdrawals

TFSA Over-contribution Penalty.

CRA will charge you 1% per month on the excess amount within your TFSA for as long as the excess remains within your plan. The penalty will be charged until one of the following happens:

  • The excess amount is withdrawn
  • The excess amount is absorbed by unused contribution room in the upcoming years.

That 1% per month penalty is applied to the first dollar of over contribution and is also based on the highest amount in your account each month.

Why are investors infringing on this penalty?

Why does there seem to be so much discussion on TFSA over-contribution and the 1% per month penalty right now? I believe there are a few reasons why.

  1. Some people just make mistakes. For example, someone dropped in at their local bank and happened to set up a TFSA and made a contribution. A few years go by, that same person goes into their Financial Advisor’s office and asks to set up a TFSA but forgot they made a contribution at the bank.
  2. I’ve also seen people who think they can have many TFSA accounts at different institutions as long as the contribution at each bank does not exceed $5,000 or $5,500.  You can only contribute a total of $5,500 in a calendar year (unless you have unused contribution room).  The limit is not per institution or account but per person.
  3. Re-contributing in the same year. This seems to be one of the more common reasons people are over-contributing to the TFSA.  The rules state that you, as a TFSA account holder, may re contribute any withdrawals you have made from your TFSA back into the Tax Free Savings Account. However, the re payment, if you will, must be done in the following calendar year after the withdrawal took place (not in the same calendar year). Unless you have the room within your TFSA to re contribute in the same year you will be assessed that 1% per month penalty.

Conclusion

I think everyone needs to set up a TFSA as soon as possible after turning 18 years of age. As I have mentioned earlier it is a great tool for whatever you are saving for. Tax sheltered growth and tax free withdrawals. You can’t get much better than that.

Related article:  When paying down debts is better than contributing to a TFSA

 

You do need to keep track of your contributions so that you know what you have put in. Also, to make it easier on yourself and your record keeping try to have only one TFSA at one institution. Some of the problems I have seen arise from the fact that people have many TFSA’s at many different institutions which hinder their ability to track their contributions.

Written by Scott Wallace

Scott Wallace has been in the Insurance and Investment industry for the past 19 years. His role is to take what is important to his clients and help them make those dreams a reality. Scott is a CFP, CLU and a Qualifying and Lifetime Member of the Million Dollar Round Table.

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