Client confusion persists

Some clients also seem foggy about how the accounts work. Last year, 100,000 TFSA holders received letters from the CRA about possible overcontributions in 2010. This year, 76,000 clients received similar letters regarding the 2011 contribution year. Among this year’s crop, 15,000 people have received such a letter for the second time.

This points to a persistent need for financial advisors, financial services institutions and the Canada Revenue Agency (CRA) to do more to educate people about TFSAs.

The rules are pretty simple: a maximum of $5,000 can be deposited annually, and any unused contribution room can be carried over to the next calendar year. Although contributions are not tax-deductible, both the earnings accrued in the accounts and any withdrawals are tax-free. Further, when your client makes a withdrawal, an amount equal to the amount withdrawn is added to the following year’s contribution room.

Many overcontributions have occurred as a result of clients misunderstanding the contribution room created by withdrawals.

For example, if your client had opened a TFSA in January 2012 with a deposit of $5,000, maxing out his or her contribution room, then withdrew $1,000 in July of that year, the client would create $1,000 of additional contribution room for 2013.

However, many clients incorrectly assume that the contribution room created by a withdrawal is available immediately. If the same client makes another contribution before Jan. 1, 2013, he or she will have overcontributed by the deposit amount and could be subject to a penalty of 1% of the overcontribution per month.

The CRA acknowledges that many TFSA accountholders still may genuinely misunderstand the TFSA rules. In such cases, and if the overcontribution is removed within a “reasonable” period of time, says Philippe Brideau, the CRA’s senior media relations advisor, the penalty may be waived: “The CRA recommends that anyone who has already overcontributed to his or her TFSA for the 2012 contribution year withdraw the excess as soon as possible. [Doing so] will reduce the amount of excess contribution taxes that could be payable for 2012.”

Such misunderstandings, says Rosanna De Jong, manager of financial planning with Royal Bank of Canada (RBC) in Toronto, suggest a significant opportunity for advisors to educate their clients on how TFSAs can help those clients meet their goals.

When RBC’s advisors meet with clients, De Jong says, a TFSA is recommended to them “100% of the time” because of its taxeffectiveness: “To be able to let their money grow tax-free and avoid any kind of tax implication when it comes out is a win/win. We just have to educate [people] more.”

Advisors should reinforce that any client with the ability to save even a small amount should consider a TFSA as an option, De Jong adds: “It could be in conjunction with an RRSP or outside of an RRSP. [A TFSA] should be brought into the equation when clients are able to save.”

Charlie Spiring, vice chairman of Montreal-based National Bank Financial Ltd. in Winnipeg, attributes much of the ignorance to the fact that TFSAs are relatively new and their contribution limit is relatively low for many clients. (The latter could change for some clients who have yet to open a TFSA. With the carryover of contribution room, some couples could be eligible to deposit up to $40,000 this year.)

The timing of the launch of the TFSA, which was introduced in 2009 – during the financial crisis – didn’t help, Spiring adds. Many families that have had their budgets squeezed because of the downturn may be making only RRSP contributions to take advantage of the tax deduction.

© 2012 Investment Executive. All rights reserved.