To take full advantage of the tax-deferred growth available when investing in a tax-free savings account (TFSA), many Canadians strive to maximize their TFSA contributions as early in the year as possible. However, while the goal with a TFSA should be to contribute as much as you can within the limits of your available contribution room, you also need to be mindful not to over-contribute. Putting more money in a calendar year than you’re allowed by law could result in penalties. The severity of which will depend on the circumstances of the over-contribution.
In this article, we explore the recent comments provided by the Canada Revenue Agency (CRA) on the potential implications of over-contributing to your TFSA – either when the over-contribution was unintentional or when the over-contribution was deliberate.
Over-contributions made by mistake
Perhaps you unintentionally over-contributed, because you believed you had more contribution room available than you actually did.
- The CRA confirmed that those over-contributed amounts will result in a 1% penalty tax assessed on the over-contributed amount (technically referred to as the “excess TFSA amount”).
- This penalty tax is calculated monthly, based on your highest excess TFSA amount for that month, and this penalty tax will continue to apply for each month that the excess amount remains in your TFSA.
What can you do?
- In an effort to minimize this penalty, you should plan to withdraw the excess amount as soon as you become aware of the issue.
- Also, new TFSA contribution room that becomes available each year will also serve to reduce an excess TFSA amount.
- So, in situations where you’ve identified you’re in an over-contributed state in your TFSA and its near the end of the year, waiting until the new year may help eliminate the excess amount and avoid having to withdraw anything.
Where you’ve over-contributed on purpose and it is determined to be a "deliberate over-contribution" based on the requirements of the Income Tax Act, the CRA confirmed that you will be subject to:
- the 1% penalty tax on the excess amount as outlined above, plus
- a 100% “advantage” tax which is calculated on any income or capital gains attributable to the deliberate over-contribution.
Basically, whatever investment earnings or gains you generated on the deliberate over-contribution will need to be paid to the CRA as the advantage tax, along with the 1% penalty tax. This advantage tax continues to apply until you withdraw the deliberate over-contribution AND any associated income and capital gains from your TFSA.
How would the CRA know whether an over-contribution is a deliberate over-contribution or a mistake?
The reality is they won’t necessarily know and would need to review all the facts pertinent to your situation to come to a conclusion. That said, however, the CRA did also indicate that it “will closely examine any unusual TFSA transactions and will challenge aggressive tax planning where appropriate.”
Ultimately, understanding the implications of being over-contributed ensures you can act quickly when an issue is identified. This should also provide the foresight to avoid any aggressive planning or schemes with your TFSA that may seem ‘to good to be true.’
Where you are unsure of your contribution limit, the best source to confirm your available room is with the CRA themselves – typically through the My Account portal via their website. A couple of notes to keep in mind:
- The amounts provided by the CRA are based on the prior year’s information, so their information won’t include any transactions that have occurred in the current year.
- If you’re unable to obtain that information from the CRA (perhaps you don’t have My Account set up), you can likely calculate what your limit is on your own.
- This year’s TFSA contribution limit for 2020 is $6,000. The lifetime limit for 2020 is $69,500. So, if you’ve deposited some money over the years, just subtract that number from your total lifetime limit to arrive at your maximum contribution.
- Also, if you've made any withdrawals from your TFSA you can recontribute them the year after you made the withdrawal.
For more information on TFSAs, including the reporting and filing requirements for over-contributions, see CRA Guide RC4466, Tax-Free Savings Account (TFSA), Guide for Individuals.