Following the TFSA rules can save grief, money
A tax-free savings account (TFSA) is supposed to let you completely avoid paying tax on investment income. Unfortunately, some Canadians receive letters telling them to pay tax on their TFSAs — either for contributing too much or for earning business income.
The TFSA rules explain how excess contributions will be penalized at the rate of one per cent of the excess per month.
Suppose, for example, that you made a cumulative total of $46,500 TFSA contributions by early 2016. Next, you made a $10,000 TFSA withdrawal in mid2016. Then you replenished your TFSA by making another $10,000 contribution in October 2016.
The Canada Revenue Agency (CRA) considers you to have made an excess $10,000 contribution for the three months from October through December. Your TFSA over-contribution penalty would be $300. In this scenario a better way to replenish your TFSA would have been to wait until January 2017 to make the $10,000 re-contribution.
How do you know how much you can contribute to your TFSA for 2017?
Your 2017 TFSA contribution room is shown on your ‘My Account’ page on the CRA website. Room is calculated based on information received by CRA from financial institutions about TFSA transactions from 2009 to Dec. 31, 2016. Before adding to your TFSA, also review your financial institutions’ records for any subsequent TFSA contributions and withdrawals in 2017.
Yes, you can have TFSAs at two separate financial institutions. You would avoid penalties if you deposited to each TFSA and stayed within your overall limit. But having more than one TFSA makes it far too easy to be penalized for excess contributions.
If you have more than one TFSA, you can make a direct qualifying transfer between TFSA accounts without affecting contribution room. An indirect transfer (withdrawal) can trigger an over-contribution penalty.
Keep it simple. Have only one TFSA
What if you contribute TFSA money inherited from your deceased spouse to your own TFSA? Use form RC240 to designate your inherited TFSA funds as an exempt contribution — especially if your spouse had not designated you as ‘successor holder.’
Suppose you discover that you have inadvertently deposited too much or made a premature re-contribution of an amount withdrawn earlier in the same year? Stop the penalty clock by withdrawing the excess TFSA contribution before the end of the current month.
If CRA has notified of you of excess TFSA contributions, pay the penalty in full by the due date. Pay even if you think the CRA made a mistake. If you don’t pay on time you will be charged five per cent interest and receive nagging reminders from CRA.
Then, write a letter to request relief. If you are lucky, your penalty may be waived if you explain how you genuinely misunderstood the contribution rules and your net contributions never exceeded $46,500.
What if you trade securities actively in a TFSA and you are deemed to be carrying on a business? CRA can and will assess taxes at their discretion.
What about an investment guru who amasses over a million in a TFSA with a series of high-risk gambles on penny stocks, initial public offerings and warrants? This expert makes spectacular gains by making dozens of online trades per day over the years. The CRA can assess tax by claiming there was active business income earned in the TFSA.
Terry McBride, a member of Advocis, works with Raymond James Ltd. The views of the author do not necessarily reflect those of Raymond James Ltd. Information is from sources believed reliable but cannot be guaranteed. This is provided for information only. We recommend that clients seek independent advice from a professional adviser on tax-related matters. Securities offered through Raymond James Ltd., member of the Canadian Investor Protection Fund. Insurance services offered through Raymond James Financial Planning Ltd., not a member of the Canadian Investor Protection Fund.