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Penalized for a TFSA overcontribution? The case for a temporary amnesty

You won't believe Andy Tesluk's TFSA nightmare in triplicate.

Mr. Tesluk is a 63-year-old former IT guy in the financial services industry and a resident of Cobourg, Ont. In the spring, the Canada Revenue Agency notified him of a $1,300 overcontribution penalty on his own tax-free savings account, and the same amount for TFSAs he manages for his wife and mom.

"My heart was down in my pants," he recalls of the moment when the letters from the CRA arrived. "My mom is 92 and living in an old folks home, and she's getting hit with a $1,300 penalty."

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The CRA reviewed the penalties and withdrew them after Mr. Tesluk wrote letters to explain how he misunderstood the rules for contributing to TFSAs. But his story highlights a continuing flaw in an otherwise hugely successful program to encourage saving. Too many Canadians do not understand the rules on how to put money back in a TFSA after withdrawing it.

We need the federal government to declare a temporary amnesty for these people. Send them stern warning letters, but hold off on penalties that are only giving TFSAs a bad rep. Mr. Tesluk himself has warned his adult children against them. "I told them, don't bother with TFSAs – they bite."

TFSA penalties are not an epidemic. The federal Department of Finance says 10.7 million Canadians had opened a TFSA by the end of last year, and more than 99 per cent have followed the rules.

The latest numbers, presented in a Canadian Press story this week, show that 54,700 or so taxpayers were contacted by the CRA about overcontributions in the 2013 tax year. In a February column, I reported that about 74,000 people had received notices for 2012. Back in 2010, the number was 103,000.

According to the CP report, the CRA waived penalties averaging $516 for more than 17,000 people who were tripped up by the rules in 2012. Presumably, more could have obtained waivers if they had written letters of explanation.

Even on this small scale, the TFSA overcontribution issue wastes too much time and money for both taxpayers and the CRA. Surely there are more worthy targets for the taxman.

Mr. Tesluk's story shows just how easy it is for even financially astute people to fall into the TFSA trap. Having ensured over time that maximum contributions were made to the three accounts he looks after, he decided early last year to move money in each from one online bank to a competitor in order to take advantage of a temporary interest rate promotion at the rival bank.

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In the summer, with the bonus rate deal expiring, he moved the money back to the original bank. This is what put him offside with the CRA. If he'd waited until 2014 to put the money back, he'd have been fine.

The Department of Finance, which designed the TFSA, says the current rules are set up to allow an individual's contribution room to be determined in a simple way. Financial companies report their client TFSA holdings to the CRA by the end of each February. The CRA, in turn, keeps track of contribution room and assesses penalties where warranted.

A person can have multiple TFSAs at a variety of banks and investment firms, so there's no way for individual companies to keep track of individual contribution limits. Finance argues that if people were able to freely put back withdrawn TFSA money in the same year, they would have the burden of keeping track of every withdrawal and contribution on their own. This would increase the risk of taxpayer miscalculations and unintended overcontributions.

Individuals certainly have an obligation to understand the rules of the financial products they use. But the federal government has tacitly admitted Canadians lack financial literacy. That's the story behind the recent appointment of a Financial Literacy Leader who will co-ordinate efforts to help people handle money more intelligently.

An amnesty for people who accidentally put too much money in their TFSAs is an ideal opportunity to focus attention on these exceptionally useful savings vehicles. The government can help, but so can the financial services industry by acting as a screen against ill-considered TFSA withdrawals. For example, people transferring money into a TFSA online should be asked whether they're sure they have the contribution room, and also shown how to calculate this room.

Mr. Tesluk praised Tangerine, the online bank where those three TFSA accounts are now, for recently introduced a warning like this. "It's just something that says: 'Hey, do you know what you're doing?'"

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TFSA overcontributions

Background: A significant benefit of TFSAs is that you're allowed to withdraw money and then put it back.

Problem:People who annually max out their TFSAs are taking money out, putting it back in during the same calendar year and then receiving overcontribution penalty notices from the Canada Revenue Agency.

Background:You can only recontribute money to a TFSA in the same year as a withdrawal if you have available contribution room; if you do not have the room, CRA sees you as having overcontributed.

Penalty for overcontributions:1 per cent of the highest excess TFSA balance in a month; applies for each month you have an excess balance.

An easy penalty-avoidance rule:If you withdraw money from a TFSA, do not replace it until the next calendar year.

Another thought:A direct transfer of a TFSA account from one financial firm to another will have no tax consequences.

More info from CRA: Click here

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About the Author
Personal Finance Columnist

Rob Carrick has been writing about personal finance, business and economics for close to 20 years. He joined The Globe and Mail in late 1996 as an investment reporter and has been personal finance columnist since November 1998. Rob's personal finance columns appear in The Globe on Tuesday and Thursday, and his Portfolio Strategy column for investors appears on Saturday. More


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