The introduction of the tax-free savings account broadened the range of savings options you can offer your clients. But many TFSA investors, having failed to fully understand the limitations of these savings vehicles, leared they could be subject to penalties for exceeding their annual contribution limits.

How do you make sure your clients don’t get any unpleasant surprises with their TFSAs?

“Make your clients aware that there are limits to TFSAs,” says David Ablett, director of tax and estate planning with Investors Group Inc. in Winnipeg. “And tell them penalties apply when they exceed those limits.”

First, the basics

To help clients understand the concept of a TFSA, Ablett suggests, compare a TFSA with an RRSP. Explain that clients receive a tax benefit on their RRSP deposits, but pay taxes when, eventually, the money is withdrawn, either from the RRSP or through a RIF.

Adds Ablett: “Tell clients that, with a TFSA, they don’t get a deduction for the contributions. But then, when they withdraw money from the TFSA, none of it — principal or earnings — is taxable.”

Another important advantage to TFSAs: withdrawals made from a TFSA after the client has reached age 65 will not affect his or her eligibility for government-assistance programs such as old age security benefits and the guaranteed income supplement. RRSP withdrawals, on the other hand, can affect eligibility for these benefits.

Warn them of the limits

Once clients understand the concept of a TFSA, Ablett says, it’s important to make sure they understand the contribution limits. Tell clients that a TFSA is not the same as a regular savings account, in which clients can make unlimited deposits and withdrawals (as long as they don’t become overdrawn) without consequence.

Remind clients that they accumulate $5,000 of TFSA contribution room each year. When the client makes a withdrawal from a TFSA, an amount equal to that withdrawal is added to their contribution room for the following calendar year. So, deposits in one year cannot exceed $5,000, regardless of that year’s withdrawals.

A penalty of 1% per month is assessed on excess contributions, Ablett says. So, a client who over-contributed by $1,000 would be assessed a penalty of $10 per month.

– Warn clients of the perils of moving funds from an existing TFSA to a new TFSA at another financial institution.

“Clients should not withdraw the money and then contribute it to the new TFSA,” Ablett says. “That can result in over-contribution and trigger a penalty.” Instead, he says, have the client contact the institution and request that the money be transferred directly.

– Advise clients of a new provision that enables them to name their spouse or common-law partner as the successor holder of the TFSA in case of death.

– Be sure to disclose any annual administrative fees associated with the TFSA product. If your client is shopping for a TFSA on his or her own, equip them with this list of questions to ask:
– Are there fees for withdrawals from this TFSA?
– Are there deferred sales charges if I make a redemption before a specific length of time?
– Will I be charged investment-management fees?

IE