Demystifying TFSA rules to avoid hefty penalties
Tracking your contributions and withdrawals is critical
The TFSA limit keeps changing and I’m having trouble keeping track of how much I can contribute and how much I’ve taken out. Right now, my TFSA is worth about $90,000 and I’m told I can contribute $7,000 for 2024, with a total lifetime limit of $95,000. If I add the $7,000, I’ll have too much in the account and I don’t want to pay any fines. It seems a lot of rules apply to the TFSA and I’m afraid to make a costly mistake. Should I put in $7,000; or only $5,000, just to be on the safe side? You are correct: tax-free savings accounts do have several important rules to be followed. Let’s review them, so you know your next best move for your TFSA — both now and in the future.
TFSAs, established by the federal government in 2009, provide fabulous opportunities for investing. As the name suggests, no taxes apply to any investment income earned in a TFSA, nor is any tax owing when money is withdrawn. These tax benefits make TFSAs marvellous for just about any investment purpose, including retirement savings, education funding, gifting to family or charity, an emergency fund, a holiday account or other expenditures, such as a new vehicle.
The contribution limit is indeed $7,000 in 2024. New contribution room becomes available each calendar year and the limit has historically varied between $5,000 and $10,000.
The annual limit is indexed to inflation using the consumer price index (CPI) as reported by Statistics Canada and rounded to the nearest $500. The federal government announces each year’s TFSA limit late in the previous calendar year.
Since the inception of the TFSA, the total current cumulative limit is $95,000. Unused contribution room in any year can be carried forward indefinitely to future years.
It’s important to distinguish that the limit is based on contributions, not market value.
Although your TFSA approximates $90,000 today, you likely contributed less than this amount and the investments increased to the current $90,000 in value. (Of course, you could have contributed more than this amount and the investments decreased in value to the current total of about $90,000.)
We must be very conscientious about total TFSA contributions and withdrawals because there are hefty penalties if you find yourself in an overcontribution position. The Canada Revenue Agency (CRA) levies a penalty of one per cent per month for any amounts in excess of your maximum limit.
Your financial institution reports your TFSA contributions and withdrawals to the CRA, which calculates your contribution room on Jan. 1 for the previous tax year and subtracts the total contributions you made in that same period.
This determines the maximum you could have contributed to your TFSA by Dec. 31 of that year.
(If that amount is negative, you have over-contributed and you ought to withdraw that excess amount to avoid those significant penalties.)
If you have maximized your TFSA contribution room and you then make a withdrawal, you cannot recontribute those funds until the following year, or the excess amount will be subject to the monthly penalty.
To find your personal TFSA contribution room, log into "My Account" at canada.ca/my-cra-account and select the RRSP/TFSA tab.
This calculation will collate all of your contributions and withdrawals up to the end of December 2023. You’ll have to account for any deposits made year-to-date in 2024, as they won’t yet be reflected at the CRA. (Again, if you have already made any TFSA withdrawals in 2024, they cannot be recontributed until Jan. 1, 2025.)
Once you calculate your current TFSA contribution room, you can confidently top-up for 2024, without any risk of incurring the CRA’s overcontribution penalties.
Now that you’ve grabbed the confusing TFSA rules by the tail, I strongly encourage you to tuck away as much money as legitimately possible into this terrific tax-free environment.
As the name suggests, no taxes apply to any investment income earned in a TFSA, nor is any tax owing when money is withdrawn