Savings & Investments, Tips & Advice

Don’t Over-Contribute to Your TFSA!

If you are a person who makes a number of contributions and withdrawals to a Tax-Free Savings Account (TFSA) over the course of a year, you’ll want to ensure that you don’t over-contribute.

If you do over-contribute, you will be taxed one percent per month each and every month the excess amount stays in your TFSA account(s).

And an excess amount in a TFSA can occur at any time during the tax year. So if you over-contributed to your TFSA account in January of a tax year and didn’t notice it until you did your income tax, you would be charged monthly interest for almost an entire year!

Now, unless  you’ve made a huge error, we’re not talking about the kind of sums that will drive you into bankruptcy, as there is a limit on how long the penalty will be charged.

“The tax of 1% per month,” says the Canada Revenue Agency (CRA), “will continue to apply for each month that the excess amount remains in the TFSA. It will continue to apply until whichever of the following happens first:

  • the entire excess amount is withdrawn; or
  • for eligible individuals, the entire excess amount is absorbed by additions to their unused TFSA contribution room in the following years.”

However, small amounts add up, too, and no one likes to pay more tax than they have to.

How to Avoid Having an Excess Amount in Your TFSA

The best way to avoid over-contributing to your TFSA account is to know how TFSA contributions work.

You are considered to have an excess TFSA amount “at any time in a year as soon as the total of all TFSA contributions you made in the year exceeds the total of your TFSA contribution room at the beginning of the year plus any qualifying portion of a withdrawal made in the year up to that time” (Canada Revenue Agency).

Look at this example the Canada Revenue Agency provides:

In 2011, Judy begins the year with a TFSA contribution room of $5,000.

Judy’s contributions and withdrawals for 2011 are the following amounts:

  • Contribution on March 16 – $1,000
  • Withdrawal on June 15 – $2,000
  • Contribution on August 23 – $2,000
  • Withdrawal on September 8 – $1,000

You might think, looking at the above, that Judy is fine, TFSA contribution wise, because although she hit her TFSA limit on March 16th, she withdrew $2,000 on June 15th before she contributed another $2,000 on August 23rd.

You’d be wrong.

The Canada Revenue Agency explains, “Judy’s first two contributions, in January and March, reduced her TFSA contribution room to zero. Since her June withdrawal does not get added back to her contribution room until the following year, her August contribution caused an excess TFSA amount of $2,000 for that month. Her September withdrawal of $1,000 would be considered a qualifying portion of the withdrawal in computing her highest excess amount for the following month, October. An excess TFSA amount of $1,000 remains until the end of the year and she will have to pay a 1% tax for the months of August to December.” (our italics).

Judy ends up paying an additional $70.00 in tax.

Here are two other examples of qualifying portions of a withdrawal on the same page as the one just quoted.

The best advice? If you’re going to make withdrawals and contributions in the same tax year, keep a close eye on the overall balance of all your TFSA accounts (if you have more than one), so you can immediately make the kind of qualifying portion of a withdrawal that counts – one made during the year that was required to reduce or eliminate a previously determined excess amount.