For many Canadians, the tax-free savings account remains unfamiliar and not yet fully understood. There’s perhaps no greater evidence of that than in the fact almost 103,000 people overcontributed to their TFSAs last year, most doing so inadvertently.
As a result, the Canada Revenue Agency and the financial services industry say they are taking steps to help Canadians better comprehend the rules governing TFSAs.
In late August, the CRA sent out letters to about 1.5% of the almost 6.7 million TFSA holders about a possible overcontribution in 2010. That proportion stayed comparatively steady compared with last year, when 73,000 Canadians out of the 4.8 million who opened TFSAs in 2009 received letters.
Both this year and last, the CRA offered Canadians who overcontributed the opportunity to ask the agency to review their cases, indicating it would provide amnesty from taxes if the overcontribution was accidental. Said the CRA in a statement: “Our intention is to review each situation on a case-by-case basis and, where appropriate, waive taxes on excess contributions.”
The TFSA, introduced in 2009, allows adults to contribute up to $5,000 a year. Contributions are not deductible for income tax purposes, and income earned in the plan also is not taxable. Any unused TFSA contribution room is carried forward and accumulates in subsequent years. Any withdrawal made from a TFSA is free from taxes — and an amount equal to the amount of the withdrawal is added to the TFSA holder’s contribution room for the following year.
However, if a TFSA holder overcontributes to the TFSA, he or she is assessed a penalty of 1% a month on the excess contribution.
Taxpayers who received the letter were sent a TFSA return form, a TFSA transaction summary and a detailed excess amount calculation form indicating how much the CRA believes the taxpayer had overcontributed and what the taxes on the overcontribution would be. These taxpayers were given 60 days to pay the taxes, contest the CRA’s calculations or ask for the penalty to be waived.
The CRA announced its most recent amnesty for accidental overcontributors after a report this year from the taxpayers’ ombudsman criticized the agency for not doing enough to educate taxpayers on how TFSAs work. Tax experts have lauded the CRA’s amnesty offer, noting the agency is right to show patience.
“The CRA has done an admirable job,” says Adam Salahudeen, director of taxation advisory services, wealth management division, with Bank of Nova Scotia in Toronto. “It’s trying to make sure the TFSA is a benefit to Canadians — not a taxable event.”
TFSA holders seem to run into overcontribution problems primarily in one of two ways.
The first is withdrawing from the TFSA and then contributing in that same year in a way that puts the TFSA holder over the contribution limit. For example, a TFSA holder that contributes $5,000, then withdraws $2,000, then contributes $500, all in the same calendar year, would have overcontributed by $500. Withdrawals create contribution room in subsequent years.
The second is withdrawing from and closing a TFSA account at one firm and then opening and contributing to a TFSA at another firm in such a way that the holder has inadvertently overcontributed. A TFSA holder who wants to move a TFSA from one firm to another should ask the first firm to transfer the account to the second, which won’t trigger taxes.
In order to help clients better understand how TFSAs work, the CRA will improve its TFSA-related web pages, issue tax tips, work with media and conduct webinars about TFSAs for financial services firms. Financial services firms, for their part, are trying to help clients prevent TFSA missteps. IE