Tax Free Savings Accounts (TFSAs) are one of the most convenient ways for most Canadians to build up tax-free assets to fulfill their financial goals or build up an emergency fund. However, most Canadians seem to be unsure in regards to certain rules applicable to TFSAs, which could lead to severe penalties.
The Canada Revenue Agency (CRA) presented an estimate of almost 74,000 people who were sent notices about TFSA over-contributions in 2012, a bit less than the cases in 2011 and 2010 which were 76,000 and 103,000 respectively. The number is small compared to the more than nine million Canadians that hold a TFSA; nevertheless, it is important that individuals are informed about the applicable rules associated with this type of plan/account the potential to avoid time and cost implications of CRA audits, negotiations and case closure.
Despite annual warnings, there still remains reportable cases of penalties for over contribution into TFSAs every year. In our efforts to help taxpayers be as informed and tax-compliant as possible, AG Tax analysts have prepared a brief overview of the contribution and withdrawal rules associated with TFSAs.
Tax Free Savings Account (TFSA) & Associated Tax Rules
Individuals, aged 18 and above, can contribute after-tax dollars up to a certain limit ($5,500 for 2014, any additional contribution would be subject to penalties) into a TFSA, and he/she would not be liable to pay any taxes on any withdrawals made, income earned, or capital gains accrued through the sale of the asset.
TFSA Withdrawal Rule
It may seem confusing on receiving a notice from the CRA regarding over-contribution into a TFSA when you quite well remember putting in exactly within the allowable limits (up to $5,000 annually before 2013, and $5,500 for 2013 onwards). Often account owners fail to remember the rule associated with making a withdrawal from the TFSA.
Depending on the liquidity of the investment held in a TFSA, an individual can withdraw funds anytime from his/her account. However, the withdrawal made is considered to be from the existing balance of the account and not from the contributions made during the year. Therefore, if an individual makes a withdrawal from a TFSA, he/she cannot repay the account within the same year unless it is a qualified transfer or other qualifying reasons. Any amount in excess of the allowed limit is considered as over-contribution, even if an individual is trying to return the withdrawn money.
Example: In June 2013, Katherine contributed the maximum allowed amount of $5,000 into her TFSA. By September 2013, she withdrew a sum of $2,000 to purchase an item, and was left with $1,000 which she intended to put back into her TFSA. However, as per the rules, Katherine cannot do so since she has already maxed out the TFSA contribution limit for the year. In order to re-contribute this $1,000 she would need to do the contribution in 2014 as a part of the contribution limit for 2014, following which she can only contribute an additional of $4,500 ($5,500 less $1,000) during the year.
Always remember the following points governing TFSA withdrawal:
– Withdrawals are added to the TFSA contribution limit at the beginning of the next year.
– Contribution made with regards to the withdrawn amount should be done only if the allowable limit for the year has not been exhausted.
Applicable Penalty in Case of Negligence
As per the CRA, if an individual contributes more than the allowable contribution limit, he/she will be considered to be over-contributing to the TFSA and be subjected to a tax equal to 1% of the highest excess TFSA amount in the month, for each month you are in an excess contribution position.
In the above case, if Katherine goes on to re-contribute the $1,000 in 2013 itself, she would be liable to a tax penalty of 1% on the excess contribution (i.e. the $1,000).
It is important taxpayers understand that TFSAs are worthwhile savings accounts, but being informed about them and the associated rules are equally important.
Taxpayers are strongly encouraged to consult tax professionals before investing into any savings plan and be fully informed about any associated rules/regulations, terms, and conditions with the account. One such instance of necessary information are the significant filing requirements and potential penalties for U.S. persons holding Canadian Tax Free Savings Accounts. Please consult with a qualified cross-border tax advisor before opening a TFSA if you have an U.S. ties. See this article (http://www.agtax.ca/canada-us-tax/tax-obligations-for-foreign-nationals-residing-in-the-united-states/.) here for more information.
AG Tax LLP Can Help
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canadian, and other international tax laws.
We can assist with:
- Canadian Personal and Corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
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