Canadians who contribute too much to their Tax-Free Savings Accounts (TFSAs) are subject to a 1% tax each month on the over-contribution. A quirk in the way that this tax is calculated means that it is possible to be in a state of “over-contribution” even after emptying out a TFSA.
The rules for how to calculate the TFSA over-contribution tax are explained in the form RC243-SCH-A Schedule A - Excess TFSA Amounts. How these rules can lead to getting taxed on an empty account is best explained with an example.
Sally opened a TFSA in January 2009 with the plan to invest in ABC stock. She opened an account and deposited her TFSA limit of $5000. Unfortunately, there was a misunderstanding with their bank and the account was not a trading account.
Sally withdrew the money, opened a self-directed TFSA, and deposited the $5000 not realizing that this was considered an over-contribution. The withdrawal amount of $5000 was added to her 2010 contribution room, but was not available for the rest of 2009. She could have made a proper transfer between TFSAs but didn’t realize that this would make a difference.
She went on to buy $5000 worth of ABC stock. Toward the end of January, she found out that she had made a TFSA over-contribution of $5000 and would pay a $50 tax each month. So, she sold the stock and withdrew the proceeds from her TFSA.
Unfortunately, ABC stock had lost 20% of its value before she sold it. Her withdrawal was only $4000. So, by the TFSA rules, she still had an over-contribution of $1000 as of the end of January. This was true even though the account was empty!
In addition to the $50 tax for January, Sally was hit with another $10 tax for each of the remaining 11 months of the year. At least the pain stopped in January 2010 when she got more TFSA room and the over-contribution tax stopped at a total of $160.
This type of situation seems like a logical case to waive penalties for the rest of the year, and it could be that CRA has policies to deal with empty TFSAs, but there is nothing in the information I’ve read about the 1% tax that allows for leniency when the TFSA is empty.
Do you know of any reason that withdrawals don't increase contribution room in the current year? It just seems arbitrary and confusing.
ReplyDelete@Patrick: The only reason I can think of is it is meant to encourage saving for the future rather than just saving for next week. However, this flies in the face of the usual mantra from conservative politicians who argue for personal choice.
ReplyDeleteHow to send the request for the waiver?
ReplyDelete1. T400A with a cheque
2. T400A without a cheque
3. A letter with the cheque
4. A letter without a check
And who we should send the request to?
@Anonymous: The best information I have is from the most recent Canadian Capitalist blog entry:
ReplyDeletehttp://www.canadiancapitalist.com/apply-for-waiver-of-tfsa-over-contribution-penalties/