There is widespread confusion around contribution and withdrawal rules for Tax Free Savings Accounts, and as a result, many investors are inadvertently over-contributing to their accounts, according to Jamie Golombek, managing director of tax and estate planning at CIBC Wealth Management.
In recent days, many Canadian taxpayers have received letters from the Canada Revenue Agency advising them that they’re facing penalties for making excess contributions to their TFSAs in 2009, said Golombek, who spoke at the Canadian Institute of Financial Planners’ Annual National Conference in Niagara Falls on Wednesday. He said most of these taxpayers likely did not realize that their contributions were not permitted under TFSA rules.
“I think Canadians were confused on the withdrawal rules,” said Golombek.
In many cases, he said, investors had contributed the maximum $5,000 to their TFSA early in the year, withdrew the cash to spend it partway through the year, and then re-contributed it to the account later in the year. Under TFSA rules, withdrawals made from a TFSA are added back to an individual’s TFSA contribution room at the beginning of the following year – not the same year.
“That’s what I would call an innocent misunderstanding of the rules,” Golombek said.
As a result, if an investor’s total contributions in 2009 added up to more than $5,000 – even if they withdrew cash during the year and then later topped up their account – the CRA considers it an over-contribution. Such investors are subject to a 1% tax on their highest excess TFSA amount in each calendar month in which there was an excess TFSA amount in their account.
Another common scenario that is resulting in unintended over-contributions is the transfer of funds from one TFSA account to another. Golombek said many investors who had opened high interest TFSAs decided to shift their funds to an investment account in which they could hold stocks and bonds.
But rather than going through the process of officially transferring the funds from a TFSA at one financial institution to a TFSA at another – which can take up to six weeks and can involve hefty fees – many investors simply withdrew the funds from one account and deposited them in another.
“Taxpayers are taking shortcuts,” Golombek said.
“They tried to get around the transfer rules,” he explained. “But the problem is that according to the CRA and according to the financial institution records, that was a withdrawal and then a subsequent re-contribution, which put them offside on the contribution limits.”
He encouraged advisors to ensure their clients are properly transferring funds between accounts by completing all of the required paperwork.
Further confusion is being caused by the letters that investors are receiving from the CRA. When calculating the total amount of an investor’s excess TFSA contribution, the agency multiplies the amount of the over-contribution by the number of months in which the account carried the excess amount.
As a result, an investor who had made an excess contribution of $3,000 in July, and kept it in the account for the rest of the year, would have received a letter from the CRA indicating that their excess contribution totaled $18,000. This has perplexed investors, who actually contributed a far smaller amount.
“The way the math is being done by the government is confusing all kinds of people,” Golombek said.
He expects the government to be forgiving of investors who over-contributed by mistake. Investors who are facing these penalties will likely receive a formal notice of assessment from the CRA, and Golombek said they will then have to formally object to the penalty, explaining that they didn’t understand the rules or other reasons for the over-contribution.
“You’ll probably get some sympathy,” he said. He pointed out that under a section of the Income Tax Act, the penalty tax on over-contributions can be waived in situations where someone made a reasonable error, and upon realizing the error, took immediate steps to remove the over-contribution from the TFSA.
Golombek pointed out that the government introduced new anti-avoidance rules around the TFSA in April, some of which are intended to deter Canadians from deliberately over-contributing to their accounts. These rules include a penalty tax of 100% on any income or capital gains derived from over-contributions, in situations where the CRA can demonstrate that the over-contributions were deliberate.
“If it’s not deliberate, then any income or gains do remain in the account,” Golombek said.
Jamie Golombek, managing director of tax and estate planning at CIBC Wealth Management, discusses contribution rules for Tax Free Savings Accounts and recent over-contribution penalties levied by the Canada Revenue Agency. He spoke at the Canadian Financial Planners Conference in Niagara Falls. WATCH
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