Avoid TFSA Penalties

Avoiding Penalties with your TFSA

September 2014

Tax Free Savings Accounts (TFSA) have been available since 2009 and offer a number of benefits. Contributions can be invested and the growth is accumulated  tax free, in addition money can be withdrawn at anytime without tax consequence. TFSAs are an integral part of an investment strategy and retirement plan. However, in August the Canada Revenue Agency (CRA) released numbers showing many Canadians are still running afoul of the rules and are being penalized. Some 54,700 taxpayers got warning packages from CRA for excess contributions and may face penalties. Each recipient has 60 days to respond or will receive a notice of assessment imposing a 1% per month penalty on the excess contribution. For 11,260 folks this is the second year in a row they have received this warning from CRA.

I believe the excess contributions are a result of a few factors: a tricky rule that limits when funds withdrawn from a TFSA can be added back to the account and the purpose for which some TFSAs are being used. TFSAs were introduced in 2009, at the time they had a $5,000 per year contribution limit. In 2013 that limit was increased to $5,500 per year. Therefore, an individual, who was over the age of 18 in 2009, would have a cumulative contribution limit of $31,000. If that individual, for example, made the maximum contributions every year and then withdrew $5,000 in 2014, they would not be able replace the $5,000 until 2015.  If they re-contributed the $5,000 prior to the 2015 calendar year they would be over their contribution limit. Withdrawals from a TFSA are added back to your contribution limit, however not until the following calendar year. If the money is deposited in the same year withdrawn it is counted as another contribution and could push you over the limit and result in a penalty.

In my opinion one way to bump into this tricky rule is by using TFSA as a short-term savings tool. This is a common practice and there is nothing in the rules preventing it. In addition, money can legitimately be withdrawn from a TFSA at anytime without tax consequence, which makes it attractive as a short-term savings tool. However, frequent deposits and withdrawals (which are common for short-term savings accounts) will increase the likelihood that the above mentioned rule will push you over your limit and into penalty territory.

Short-term savings are important; however I would not use the TFSA for that purpose, most financial institutions offer a premium savings or high interest savings account that would be better suited for that goal. To make the most of the tax free status of your TFSA, I encourage folks to use it as an investment account. You have the potential for a higher rate of return completely tax free. In addition, because deposits and withdrawals are less frequent in investment accounts, you are less likely to run afoul of the TFSA rules.

Regardless of the purpose of your TFSA, if you are mindful of your deposits and withdrawals and avoid the penalties, they can be an integral part of your financial plan.

Clinton Orr B.Comm (hons.), CIM, CFP, DMS, FMA lives in Beausejour and is a portfolio manager with National Bank Financial.




This information transmitted is intended to provide general guidance on matters of interest for the personal use of the reader who accepts full responsibility for its use, and is not to be considered a definitive analysis of the law and factual situation of any particular individual or entity.  As such, it should not be used as a substitute for consultation with a professional accounting, tax, legal or other professional advisor. This commentary reflects my opinions alone, and may not reflect the views of National Bank Financial Group.