What Is TFSA Overcontribution and How Does It Work?: The Ultimate Guide 2022
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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).
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 TFSAAs 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):
Savings AccountI 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) savingsI 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.
Mutual FundsI 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.
Self-Directed TradingMost 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<p 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? No? 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.
How and when Financial Institutions share data and what the data containsSo, 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 TFSAThis 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.*
How do you know you have contributed more money than you should have to your TFSA?
Keep track of your transactions yourselfIf 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 LetterWhen 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
Contributing an amount and withdrawing the same amount or more and then putting said withdrawn amount back in the same year.
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.
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.
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.**