Snags in TFSAs not surprising, it’s how we repair them that counts.

For 70,000 Canadians there was a rude awakening on tax day this year as they learned that their Tax Free Savings Accounts (TFSA) were actually going to cost them money. In late June, Revenue Canada admitted there was a problem when, they extended the period to appeal assessments until the end of July.

The popular money-management option (used by 4.6 million people) designed to help Canadians accumulate savings, offers the incentive of tax-free earnings on as much as $5,000.00 a year in a specific savings account. The accounts operate just like any other bank account with the only significant exception being the limit on the amount one can contribute in one year.

It appears many people may have misunderstood the hard limit to contributions that was placed on these accounts. As a result, people who replaced money they withdrew from accounts that were at, or near, maximum contribution levels were handed an unexpected tax bill, some of which were pretty hefty.

Confusion on the part of Revenue Canada officials and those who administer the accounts in financial institutions may have played a role in over-contributions or improperly transferred accounts, which in turn led to fines being levied by the taxman. The fines are steep too. One percent of the over-contribution level is charged for every month the money is in the account.

If you created a TFSA at one financial institution and then decide to transfer it to another institution, there was a procedure to be followed that was not widely reported. Individuals who contributed in excess of $2,500 and did not follow the appropriate transfer procedure, were told at year’s end that they had over-contributed. A person who improperly transferred a $5,000 TFSA in January would have been charged as if they had made a double contribution and been forced to pay 1% on the $5,000 over-contribution multiplied by 12 months. A tax bill of$600 was the outcome for those who did just that; an amount that far exceeds any interest one would have earned in a savings account for that period.

The same penalty formula applied for people who withdrew and later replaced money in a TSFA. If the amount they put back in, when added to the amount of their initial deposits, exceeded $5,000 the penalty was applied. In this case, imagine taking $3,000 dollars from a $5,000 TSFA in May and replacing that money in September. For tax purposes, there would be a penalty on the replacement $3,000 for the remaining four months of the tax year, resulting in a $120 tax bill, given that Revenue Canada considers this to be a total contribution of $8,000 for the year (it`s not really what is in the account for the year but more so what you deposited).

It should be noted that if you have over-contributed in a calendar year, the excess is applied to your $5,000 cap for the following year.
For most, the penalties provided sticker-shock. If you are one of the 70,000 Canadians who received a TFSA penalty you may want to take the opportunity to argue your case with Revenue Canada, as you may be entitled to having all or part of the penalty and any interest charges overturned.

New Democrats feel there is more that could be done to help people who, in good-faith, over-contributed and may wish to appeal their penalty. The program is only one year old and bugs are obviously being worked out. In the interim, it would only be fair to have a longer window for the appeal process. It may also be wise for the House of Commons Finance Committee to look into the implementation of the program with an eye to avoiding the same level of confusion with future financial incentives.

If you have questions about TSFAs and would like more information you can :
- Read about them on the Revenue Canada website - http://www.cra-arc.gc.ca/E/pub/tg/rc4466/rc4466-10e.pdf
- Speak with your financial planner or someone from a financial institution to determine what your TFSA options are
- Or call my office if you need further assistance.