Taxman may forgive TFSA rule breakers

Thursday, June 17, 2010


The Canada Revenue Agency is quietly willing to consider providing relief for people who accidentally contributed too much to their Tax-Free Savings Accounts and now face penalties that could amount to hundreds of dollars.

Just over 70,000 people have received CRA notices telling them they owe penalty taxes because of overcontributions to their TFSAs. In large part, these cases involve simple misunderstandings of the limits on how much can be contributed to a plan each year.

Rule One: The most you can put in a TFSA annually is $5,000.

Rule Two: In any calendar year, this limit applies even if you take money out of your account. Oblivious to these points, many people shunted money in and out of their TFSAs like they were savings accounts.

For example, someone might have put $5,000 in a TFSA early in 2009, taken out $4,000 at some point, then replaced it within a month or two rather than doing the right thing and waiting until the next year. The $4,000 repayment is considered an overcontribution in this case, and it's subject to a penalty of 1 per cent a month.

That's the letter of the law, anyway.

In practice, CRA is saying that relief may be available for people who mistakenly overcontributed to a TFSA.

"Because we are reviewing each and every [situation] on a case-by-case basis, it's correct to say that relief may be provided," CRA spokeswoman Caitlin Workman said Wednesday. "Each case will be looked at with the facts at hand, so I'm a little wary of issuing a blanket statement. If it was truly an error - that's what we tend to look at."

People also got themselves into difficulties with CRA by withdrawing money from a tax-free account and then putting it in a TFSA at another financial institution. It's perfectly fine to do what's called a "direct transfer" of a TFSA from one firm to another, just as people commonly do with registered retirement savings plans. The problem lies in first withdrawing cash from a TFSA and then moving it to a new account in the same year.

The TFSA overcontribution mix-up is ironic when you consider that these accounts are so often described as being both simple and flexible. In the federal budget announcing the debut of these plans on Jan. 1, 2009, TFSAs were described as offering "full flexibility to withdraw and recontribute." Elsewhere, the budget documents said the TFSA "will also provide seniors with a savings vehicle to meet any ongoing savings needs."

The big banks also have a role in the confusion, given that they held about 75 per cent of the $15.8-billion in TFSA assets at the end of last year. How is that tens of thousands of bank clients were breaking the overcontribution rules?

"As a new type of registered plan that is still in its early days, there's clearly been some confusion about the rules, which is regrettable ... ," Kelly Hechler, a spokeswoman for Toronto-Dominion Bank said in an e-mail. "Although we informed and tested sales staff on the rules, including overcontribution, clearly all parties could have done a better job of explaining the rules in promoting this valuable tax savings vehicle."

Ms. Hechler said that for customers who mistakenly overcontributed to their TFSAs, TD is explaining how to apply for taxpayer relief. The bank is also taking steps to make sure that customers are aware of contribution rules in future.

Royal Bank of Canada said it has encouraged clients to consider the TFSA as an investment account for short- and long-term goals, not as a savings account.

"Our internal and external communications materials have been clear about the withdrawal rules and TFSA contribution room," the bank said in an e-mailed statement.

TFSA overcontribution penalties must be paid by June 30 or further charges will apply. If you're fighting a formal assessment saying you must pay a penalty, try an RC4288 Request for Taxpayer Relief form. It's worth noting that the legislation for TFSAs specifically mentions that these charges can be waived or cancelled if found to be due to a reasonable error.

"That's important because in a lot of areas, CRA doesn't have the discretion to waive penalties," said Ryan Keey, a chartered account who writes for a tax information service published by Thomson Reuters.

Mr. Keey said his wife's sister has received notice of a TFSA overcontribution penalty. He suggested she pay the penalty to avoid any further charges, and then write a letter making a case to have it refunded.



Five rules for smart TFSA management

1 ) Do some research before opening a Tax-Free Savings Account

While you're allowed to directly transfer money between TFSA accounts at different firms, you can get into difficulties if you take money out and then shift it somewhere else. Avoid hassles by finding a TFSA account that's right for you and then sticking with it.

2) Note the different kinds of accounts

If you want complete flexibility to put investments in a TFSA, go for a self-directed account at a brokerage firm or through an investment adviser. Banks also sell TFSAs based on mutual funds and high-interest savings accounts.

3) Be rate savvy

Some people have opened TFSAs with banks offering teaser rates, then been disappointed when the rates declined or became uncompetitive.

4) Limit withdrawals

TFSAs are not like savings accounts that let you move money in and out at will. Use them for money you don't anticipate needing in the immediate future.

5) Ask for help

The mix-up with TFSA overcontributions shows these accounts are more complex than many people realized. If you're not certain about how they work, consult an expert for guidance before you act.

Text by Rob Carrick and Dianne Nice


Gordon Pape answers your questions

Gordon Pape, author of The Ultimate TFSA Guide: Strategies for Building a Tax-Free Fortune, answered your questions about the Tax-Free Savings Account on Wednesday - you can find it online at Here's an edited excerpt:

If I book a loss on my investments in my TFSA, can I make up the difference next year? No. You do not generate any additional contribution room if your TFSA investments lose money.

If you have stocks in your TFSA that pay a dividend and you reinvest the dividend, does it count against your contribution limit? No. Any profits can be reinvested within a TFSA without penalty.

Are there income tax considerations when transferring an entire TFSA account mid-year from one institution to another? No, as long as you transfer the account to another TFSA. Do not close one account, withdraw the money and then use the cash to open a new account somewhere else. That may result in a taxable overcontribution.

I have been hit with penalty taxes for overcontributing to my TFSA. Should I pay it and hope for a refund later or send a letter? Your best bet is to pay the tax bill and file a notice of objection. Unless the government grants a reprieve, you'll probably lose, but it's worth the effort. If you don't pay now, the Canada Revenue Agency will charge interest on the overdue amount, compounding the cost to you.

How can I transfer funds from my existing TFSA to a TFSA GIC without incurring penalties? Do I have to wait until January of 2011? If you are currently holding your TFSA funds in cash, you should be able to transfer the money to another TFSA and use it to invest in a GIC. However, there may be an account closing fee and/or a transfer fee. Check with the financial institution that holds the existing account.

Is the amount allowed for the TFSA cumulative year over year, like the RRSP? Yes. You receive a carry-forward credit for unused contribution room.

Can TFSA holdings be transferred tax-free to a child that is financially dependent? No, money cannot be transferred to another person's TFSA.

Can term deposits held in a TFSA be used as collateral to secure a personal loan? Yes. Unlike RRSPs, Tax-Free Savings Accounts can be used as loan collateral. Talk to the financial institution that holds the plan to arrange this.