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A three-way mix-up involving investors, their financial firms and the federal government has left 70,000 people with potential tax bills for over-contributing to their Tax-Free Savings Accounts.

Glitches are inevitable when a new savings program such as the TFSA is introduced, but this one involving over-contributions is a beaut. Because of a misunderstanding about the TFSA rules, people have received notices from Canada Revenue Agency informing them they may have to pay penalties, in some cases of several hundred dollars, on excess contributions to their plan.

The TFSA rulebook states that you can contribute a maximum $5,000 per year to a TFSA, and that you can take money out any time, tax-free. You can put the money back in, too, but the fine print here is key.

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Most importantly, you have to wait until the next calendar year to put money back into a TFSA. So if you put in the annual maximum contribution of $5,000 in January, 2009, when TFSAs were introduced, and then withdrew $3,000 a few months later, the earliest you could have replaced that money without incurring a penalty was Jan. 1, 2010. Do it any earlier and you end up with an over-contribution, even if you remain under the $5,000 limit.


Another subtlety is that you can't pull money out of a TFSA account and transfer it to a plan at another financial institution within the same year. Again, the amount going into the new plan is considered an over-contribution.

TFSAs are a great financial tool because you can invest or save with them and pay no tax on your gains. But they are not like savings accounts. You can't cycle money in and out at will.

Blame the government for not making this as clear as it needed to be, blame individuals for not checking the details and blame financial institutions for not having any checks and balances in place to prevent this sort of thing.

Given all this confusion, the right thing for the government to do is forgive all but the most extreme over-contributions. In the meantime, though, some people who got letters from CRA about over-contributions may have some recourse.

More than 70,000 Canadians misunderstood rules, contributed more than allowed

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Gena Katz, executive director of Ernst & Young's tax practice, advises filling out CRA form RC243-SCH-A for excess TFSA contribution amounts. The form requires you to document your month-by-month TFSA deposits and withdrawals.

"If the net deposit amount in the year is $5,000 or less, then you're fine," Ms. Katz said.

If your net contributions to your TFSA exceed $5,000, then a penalty of 1 per cent per month applies on the excess. If you don't pay that amount by June 30, interest starts accruing.

Accidentally contributed more than $5,000 to a TFSA? It may still be possible to avoid penalties for over-contributions. Paul Hickey, partner at KPMG's national tax centre, suggested using CRA's tax fairness provisions by submitting a Request For Taxpayer Relief form.

"Interestingly the TFSA provisions contain a special rule which allows the CRA to waive or cancel all or part of the penalty if you can establish "to the satisfaction of the Minister that the liability arose as a consequence of a reasonable error," and that the individual acts without delay to fix the problem," Mr. Hickey said in an e-mail.

Investor Education: TFSAs

  • TFSA or RRSP: How to choose?
  • Careful, that TFSA can be such a tease
  • Note to Flaherty: TFSAs are good but they can be so much better
  • Using a TFSA can help get retirement plans on track
  • The right way to use a Tax Free Savings Account
  • Learning from TFSA's rule book

The rules for contributing to a TFSA are explained on the Websites of the CRA and many financial institutions. But tax professionals have some sympathy for people who failed to grasp the intricacies.

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"It's not intuitive," Ms. Katz said. "The promotion of TFSAs was that you can do what you want with it, whenever you want."

The TFSA program was announced in the 2008 federal budget, which meant financial institutions had the better part of a year to prepare for it. Still, they obviously lacked the ability to highlight cases where clients were making TFSA re-contributions in the same year as they made withdrawals. "It's not like people made the mistakes themselves," Mr. Hickey said.

Given that that there is a lot of blame to be spread around, he suggested the government might want to waive penalties for TFSA over-contributions. "If there's enough people in this situation, you would hope it would strike a chord," Mr. Hickeysaid.

When it fine-tuned TFSA regulations last fall, the federal government targeted over-contributions in highly speculative transactions where a tax-free investment gain far outweighed the penalty for putting an excess of money into the plan. However, there was no warning that rank-and-file investors were heading into trouble with over-contributions.

<iframe src="" scrolling="no" height="650px" width="600px" frameBorder ="0" allowTransparency="true" ><a href="" >Got a TFSA question?</a></iframe>

Investing Mistakes:

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  • Three common mistakes investors make
  • Market problems? Blame investors
  • Bad habits sow bad investments
  • How mind games can destroy a portfolio

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