Dear Soon-to-be-financially independent-person,
Grace and peace be with you as you continue on in your journey to be financially independent. Grace to you and me as we navigate the very many booby traps that litter the terrain of our journey.
So you got this letter from the CRA which says that you over-contributed to your Tax-Free Savings Account aka TFSA… now, that’s not good.
In this letter, I’ll do my best to explain what a TFSA is and it will be brief. You’ll also find out how much you can contribute. And no, the bank manager trying to sell you a TFSA investment account may not have the numbers right.
In the end, you will know the common mistakes people make that lead to over-contributing to their TFSAs. You will also know what you’ll need to do if, and when, you get the TFSA assessment letter.
What is a Tax-Free Savings Account and how does it work?
A Tax-Free Savings Account, also known as a TFSA account, is one of the best things ever to happen to Canadians, but sometimes, it can become a double-edged sword. It allows Canadian residents save and invest money without paying taxes on the profit/return on your investments or savings. We’ll briefly look at how it works.
When did the TFSA start in Canada?
The Tax-Free Savings Account (TFSA) started in 2009 and the idea was to get Canadians to save and grow their savings without paying taxes on the gains. You can also withdraw anytime without paying taxes on your withdrawals, unlike RRSPs.
To open a TFSA account, you must:
- Be 18 years old or depending on your province, it could be 19.
- Be a Canadian resident
- Have a valid SIN (this is the number that identifies you as a tax-paying resident).
The Government of Canada gives a new contribution room every year. Everyone gets the same contribution room. If you weren’t able to use up your contribution room from the previous year, you can carry what’s left over into the new year.
Let’s say you have a contribution room of $6,000 in 2022 and you can only contribute $4,000. You’ll have a $2,000 room in 2022 that you haven’t yet used. In 2023, if everyone gets a new contribution room of $6,000, you’ll have $6,000 plus the $2000 left over from 2022.
You can have multiple TFSA accounts but you’ll have to stay on top of things, else you’d miss some contributions you made and risk over-contributing.
This means a lot more Canadian residents need to take advantage of their TFSA accounts. Yes, the TFSA can be a double-edged sword if you aren’t careful to find out what you can contribute but, this worry is not enough for you to miss out on tax-free savings/return on investments. No pun intended, it is what it is.
How much can you put in a TFSA if you have never contributed?
If you had never contributed to a TFSA before, and you have been a resident of Canada before 2009 or you became a resident in 2009, you can pay $81,500 into a TFSA. Check the Canada Revenue Agency website to find a breakdown of the contributions available for each year. The CRA is the government agency that deals with taxes.
|Calendar Year||Amount you can contribute each year|
Types of accounts you can use for a TFSA
As I mentioned earlier, you can have multiple TFSA accounts. You only have to be on top of things so you don’t over-contribute. Right now, I have a TFSA trading account with Wealthsimple and a TFSA savings account with CIBC and EQ Bank. Here are the type of TFSA accounts you can have (this list is not exhaustive):
I use EQ Bank’s high-interest savings account for some of my TFSA funds. At the time of this letter, the bank pays 1.65% a year on their basic savings account. On a side note, you can have a US Dollar savings account with EQ Bank and earn up to 1% per year. Other than investing in the stock market, that’s the best deal I’ve seen.
Guaranteed Income Certificate (GIC) savings
I do not have a GIC savings account, just because I don’t want my money locked up for a period. However, if you don’t mind that, EQ also allows a TFSA GIC which, at the time of this video, pays 4.35% interest for ‘imprisoning’ your funds with them for a year. If you use the referral link to open an EQ Bank account, we both get $20. It comes at no cost to you and helps keep the website running and my letters coming.
I have a TFSA mutual funds account with CIBC. The return on investment was decent, almost 7% in the 3 years since I opened it. However, I withdrew most of the money to take care of an emergency and I intend to contribute to the account soon.
Most of my TFSA savings are in a self-directed trading account. I believe that this is the way you can fully use the benefits of a TFSA. In 2020, when the markets were at all-time highs, my TFSA account grew by almost 30% in one year. I also purchased dividend-paying stocks, so not only is the account growing by an average of 5-6% per year (despite the downturn in the markets this year, I’m only down 5% or so for the year 2022 on Canadian stocks. Remember, I was up 30% last year, that means in 2 years, my account is still up 25%) I also get paid dividends which I can reinvest into the account or withdraw.
At the time of this article, I use the Wealthsimple trading account and buy mostly Canadian dividend-paying stocks. Though US stocks seem to have more monetary value, you’re taxed on the proceeds of your dividend in a TFSA and the US market is more volatile.
Percentage of Canadians who contribute to their TFSA by income
Sure, you would say that, from the graph/image above, only those with high income can contribute to a TFSA. That doesn’t matter. The most important thing is to start; it’s to save, after a while, it becomes easy. Have you seen the struggle seniors who only have their Old Age Security (OAS) and Canada Pension (CPP) go through?
That’s why. But I promise you, you don’t want none of that.
Start with $10 a week, heck! $10 a month. You’ll thank your future self.
If you want to know the Canadian stocks I have in my Wealthsimple TFSA, let me know in the comments below.
Also, if you decide you want to open a Wealthsimple account as I did, I’ve got my referral link. According to Wealthsimple, we both would get rewards valued between $5 and $3000 with an average of $10 once you fund your account. Around 99% of people will receive less than $50.
How and when Financial Institutions share data and what the data contains
So, in March or April of every year, your financial institution(s) sends the CRA details of the amounts you contributed or withdrew from your TFSA as of December 31st of the previous year.
For example, your financial institution(s) will, in March or April 2022, send details of all your contributions to your TFSA accounts in 2021 from January 1, 2021, until December 31st, 2021. The banks do not send any transactions that occur in 2022 even though they get around to sending the information in March/April 2022.
How to find out how much you can contribute to your TFSA
This can be tricky if you don’t know where to look. Your CRA online account should not be the first port of call at the start of the year. Instead:
Call the Canada Revenue Agency (CRA)
Call the CRA to find out what room you have. You also have to make this call between March and April.
Also, if you’re an immigrant, make sure your entry/immigration date into the country is correct at the CRA. This is because, at first, the contribution room calculates from the inception of the TFSA program. Once you or any government agency update your immigration details, the system gives the correct contribution room you have.
If you don’t make sure this is kosher/good, and the CRA, as they usually do, recalculates the right entry date ‘500 years’ down the line, you’ll be owing taxes for overcontribution plus interest and penalties beginning from the very year the overcontribution started.
Yes, I know, I thought of Shylock too.
Also, by March/April, the CRA should have received information from all the financial institutions you have TFSA accounts, even those you may have forgotten about. This gives you the clearest picture if you have not been tracking the information yourself.
*Please note that checking your CRA account in January may not give you the most recent/accurate data. Remember, that number gets updated when your financial institution/bank sends the details in March/April.*
Also, be wary of your financial institutions trying to sell you a TFSA product and asking you to move money from one account to the other. This has caused a lot of grief for people who don’t know what their room is or the withdrawal and deposit rules of a TFSA. I’ll talk about this later in this letter.
Though the intentions of your account manager are good, they don’t always know what your contribution room is.
How do you know you have contributed more money than you should have to your TFSA?
Keep track of your transactions yourself
If you keep track of your contributions alongside your contribution room, you will pick up on this. If you find that this is the case, withdraw the amount immediately.
TFSA Assessment Letter
When you get the dreaded letter from the CRA, then sweets, you know you’ve over-contributed.
Unfortunately, those are the only two ways to know. No one will let you know that you have gone over the amount except yourself or the CRA. This is usually a rude shock to people who feel they should have been notified before being taxed.
Usually, the tax letter comes in July and sometimes has an added penalty and interest to the TFSA tax you are required to pay. This is again because the CRA believes you should have a handle on your contributions and withdrawals just like you would a normal bank account.
Since you are required to know the ins and outs of your TFSA account, when you find out about the over-contribution, the CRA also expects you to withdraw the excess and file a TFSA tax return by June 30 of the following year.
For example, if you realise you were over the contribution limit in May 2022, file the TFSA taxes by June 2023.
Common Mistakes that lead to over-contributing to your TFSA
Working with wrong information
I’ve spoken to you about how to find what you can contribute. Remember, your CRA my account may not give you the most recent data for the year. This data will change or remain the same after your financial institution/bank has sent in the details to the CRA.
Do not run with what your bank/financial institution has told you, especially if you have more than one TFSA account. It’s better to err on the side of caution and wait for the data to come in.
If you want to know the best time (and also the worst time) to contribute to your TFSA, click the link to the PDF report below. I’ll also add in a list of what you will need to have included in a relief letter if the CRA has asked you to pay taxes. There are no guarantees with the response you’ll get, but it’s best to give them the details they want for them to consider your letter.
The safe bet is to wait a month after the banks/financial institutions send in this information. Compare the information your CRA account had at the start of the year, with what it has after April. It’s unlikely it’ll match.
Allowing your bank/financial institution to sell you a TFSA product without doing your due diligence to find out how much you can contribute. And you believe your them when they say you have enough room. Hold up! Check first..
Contributing an amount and withdrawing the same amount or more and then putting said withdrawn amount back in the same year.
Check out the examples in the boxes below:
For example, let’s say you can only contribute $10,000 in 2022. If you contribute $10,000 in April 2022 and then withdraw $5,000 in August 2022, wait until 2023 to put back the $5,000 you withdrew. If you put back that $5,000 in 2022, it is an over-contribution..
John has made all his contributions of $6,000 in 2022. The total amount he has contributed to his TFSA in 5 years is $20,000. All of this amount sits in his RBC TFSA savings account, giving him 0.5% interest a year. John reads Robin’s letter on Dollar Chronicles talking about an EQ Bank TFSA savings account that pays 1.65% a year. It’s an easy decision for John, he’s going to move his money to EQ Bank.
John withdraws his $20,000 from his RBC TFSA account to his normal chequing account on September 7, 2022. He sets up his TFSA account with EQ Bank and deposits his money into his shiny new TFSA account on September 15, 2022.
John is over-contributed, unfortunately, even though he moved his money to another TFSA account. The way to do it was to request a direct transfer from John’s RBC TFSA account into his EQ TFSA account (after he must have opened the account with EQ Bank).
Contributing to your TFSA when you are outside the country or a non-resident.
Make sure you don’t make any contributions after you have left the country. Also, make sure you have the right immigration and emigration dates on your CRA account when you get back.
How are the TFSA taxes calculated?
So, the deed has been done; you have made the mistake. The CRA calculates the taxes at 1% per month on the over-contribution.
John finds out he is in an over-contribution by over $2,000. This happened in April 2022. The CRA will calculate a 1% interest for every month the account is in excess/over-contribution up until December 31st, 2022. So John will expect to pay 1% of $2000 in April, another 1% of $2,000 in May and so on until December 31st.
Using John again from Example 1. As said earlier, the excess of $2,000 happened in April 2022. John tracked his contributions and found out he was in excess in September 2022 and so he withdraws the $2,000. They will charge him a 1% tax for every month from April until September, even if he withdrew the over-contribution on September 1st.
The CRA calculates the tax as 1% for every month, there is an excess/over-contribution in the account. This is what you will get the letter/notice of in July. This notice may have penalties and interests because, remember, you were supposed to notice the over-contribution and file the TFSA taxes yourself by June of the following year.
Usually, most people only find out they over-contributed when they receive the notice. Now, by the time they receive the notice.letter for the previous year in the current year, the over-contribution has stayed in the TFSA for at least the first 6 months of the year. This means they’ll pay another 1% for the time the excess is in the account until they withdraw it.
Example: Using our earlier example, you over-contributed by $2,000 in 2022. You are unaware of this and so get a letter/notice in July 2023 for the time the extra has been in the account April 2022 – Dec 2022. After you receive the letter, you immediately withdraw the amount and pay the taxes. You will get another notice/letter in 2024 because the $2,000 has also been in the account from Jan 2023 until July 2023 when you removed it.
The only time this will not be the case is if the new contribution amount for 2023 is more than $2000. It’ll cancel out the excess.
Example: If in 2023, the contribution room is $6,000 for all Canadian residents, you will no longer have over-contributed in 2023. Instead, your contribution room will be $4000. The $6,000 contribution room has ‘swallowed up’ the $2,000. Your room for the new year is less the $2,000.
What to do when you get the TFSA notice letter?
**Always check the mail your CRA account. Many people have received this letter electronically rather than by post; and left untreated, interest continues to accumulate. Always do your due diligence by checking or calling the CRA to find out if you have anything outstanding.**
Withdraw the amount immediately.
Pay the taxes if you can, at once or in instalments. This reduces the amount of interest piling on the taxes.
Call the CRA and ask for any options you might have to ask for a waiver or review of the taxes and or penalties.
There’s no guarantee but, there’s no harm in trying. If the CRA believes this over-contribution happened unintentionally, then you could get a refund of the taxes you have already paid or not. If not, at least you’re paying only what you owe in taxes and not more. There’s no reason you should pay the government more than you owe them.
If you decide to write a letter to request a review of the taxes after you have paid or while paying, here’s a link to a report where I set out the points your letter should contain or show. This PDF includes the best time and worst time to contribute to your TFSA and how to send your request through your CRA account or by post.
I saw a website that gives a good example of a template for a request to cancel or waive your TFSA taxes. Check Tawcan’s website for the draft.Get the TFSA Report Sent to You