Fall is often a time when Canadians make excess contributions to registered plans. Sometimes, the excess is the result of pre-arranged periodic payments. Other times, the cause is windfall payments (e.g., bonuses) directed to registered plans. Regardless, excess contributions to RRSPs and TFSAs can lead to penalty taxes, so advisors and investors should be mindful of the rules. For this article, we’ll focus on excess contributions to TFSAs and discuss options for dealing with excess TFSA amounts.
TFSA contribution room, available to Canadian residents age 18 and older, is calculated as follows:
From 2009 to 2012, the TFSA dollar limit was $5,000 per year. The limit increased to $5,500 for 2013 and 2014, and $10,000 in 2015. With the election of a new government last year, the TFSA limit returned to $5,500 for 2016 and is subject to indexation for future years.
Unused contribution room carries forward to a future year, but does not accrue for any year that an individual is a non-resident of Canada. Contribution room is available, however, without proration for the years an individual turns age 18, emigrates from or immigrates to Canada, or dies. People can confirm their TFSA contribution room by accessing the CRA’s My Account , MyCRA app or Tax Information Phone Services. Or, the client can contact the CRA directly to request a TFSA Room Statement or Transaction Summary.
One of the great benefits of the TFSA is its flexibility. When an individual withdraws from a TFSA, unlike RRSPs, contribution room is not lost. The amount withdrawn is added to the individual’s TFSA contribution room the following calendar year. Consider this example:
Tina regularly contributes to her TFSA. In January 2016, she began the year with TFSA contribution room of $11,000. On February 10, she contributed $10,000 to her TFSA. Later in the year, on March 15, she withdrew $2,000 for home renovations.
Given that Tina had not yet maximized her TFSA for the year, she can contribute another $1,000 in the current year, 2016. In addition, her $2,000 withdrawal will be added to her TFSA contribution room beginning in 2017, allowing her to re-contribute the amount withdrawn.
When an individual exceeds his TFSA contribution limit for the year, the excess, referred to as a “TFSA excess amount,” is subject to a penalty tax of 1% per month. The tax is calculated based on the highest excess amount for the month and, unlike RRSPs, there is no $2,000 grace amount.
If your client owes TFSA penalty taxes, he must file a special TFSA return (Form RC243) to calculate and report the taxes. The return must be filed by June 30 of the following year, and any taxes owed must be paid by that date. If the return is filed late, additional penalties and interest may apply.
When an individual has overcontributed, he’ll owe penalty taxes for the period that he’s over his limit. But he can correct his situation and avoid additional taxes by:
- immediately withdrawing the excess amount, or,
- waiting for new contribution room to become available the following year.
With the latter option, the 1% tax would apply to excess amounts for each month up to the end of the current year. Thereafter, new contribution room would absorb the excess and, depending on the amount of new room, the tax would cease. Where excess amounts are immediately withdrawn, the timing of withdrawals is important. Consider the following example:
Tina regularly contributes to her TFSA. In January 2016, she began the year with TFSA contribution room of $11,000. In error, Tina over-contributed to her TFSA for the year. Her 2016 contributions and withdrawals were as follows:
|February 10||$10,000 contribution|
|March 15||$2,000 withdrawal|
|April 10||$2,000 contribution|
|July 13||$3,500 contribution|
In speaking with her financial advisor, Tina had the following questions.
- How much was my excess contribution for the year?
- How would the CRA calculate my penalty tax?
- How can I correct my excess contribution situation?
- How much can I contribute beginning in 2017?
How much was Tina’s excess contribution for the year?
Tina contributed a total of $15,500, which is more than her $11,000 contribution limit for the year. But is her penalty tax based on an excess amount of $4,500, or, after considering her $2,000 withdrawal on March 15, $2,500?
Although Tina withdrew $2,000 on March 15, the withdrawal occurred before she created an excess amount. As a result, she does not receive credit for the withdrawal for 2016 tax purposes. If the withdrawal occurred after her excess amount was created (i.e., after the April 10 contribution), the withdrawal would have been considered a ”qualifying portion of a withdrawal” and would have reduced her excess amount and associated taxes. Since the withdrawal occurred before Tina’s excess contribution, it does not factor into her penalty tax calculation for the year. Therefore, her excess contribution for the year was $1,000 as of April 10 and $4,500 ($1,000 + $3,500) as of July 13.
How would the CRA calculate Tina’s penalty tax?
There is no issue with the February 10 contribution as it does not exceed Tina’s contribution limit for the year. The excess contribution arises on April 10, and Tina’s penalty tax is calculated from that point forward. For 2016, the tax would be $300:
$1,000 x 3 months (Apr – Jun) x 1%, plus
$4,500 x 6 months (Jul – Dec) x 1%.
How can Tina correct her excess contribution situation?
The above calculation assumes Tina remains in an excess contribution situation for the remainder of the year. If this is the case, for penalty tax purposes, new contribution room of $7,500 ($5,500 limit + $2,000 withdrawal from 2016) would become available on January 1, 2017 and excess contribution taxes would cease. However, the monthly tax would remain payable for the remainder of 2016. Alternatively, once the excess amount is created, Tina can immediately withdraw the excess. If she did that, the tax would be payable for the month(s) in which there is an excess, but future taxes would cease.
How much can Tina contribute beginning in 2017?
If Tina withdraws her excess contribution before the end of 2016, she can contribute $7,500 beginning January 1, 2017 [($5,500 + (-$4,500) + $6,500]. If Tina does not withdraw the excess before the end of 2016, new contribution room will absorb the excess, allowing Tina to contribute $3,000 for 2017 [$5,500 + (-$4,500) + $2,000]*.
For most Canadians, dealing with excess TFSA amounts is a hassle. When faced with such a situation, however, knowing the rules will help to minimize taxes payable.
*2017 TFSA dollar limit + unused room at end of 2016 + 2016 withdrawals; Unused room at the end of 2016 is calculated as: (unused room at the end of 2015 + 2015 withdrawals + 2016 TFSA dollar limit – 2016 TFSA contributions)