While the number of people mistakenly over-contributing to their TFSAs has been declining each year, the size of individual penalties is likely to grow. This is a consequence of a common type of mistake and growing TFSA balances.
To illustrate the problem, consider our hypothetical hero Joe who dutifully fills up his TFSA every January. Like many Canadians, Joe doesn’t realize that his TFSA can be more than just a savings account collecting modest interest. It’s now January 2020, and after filling up his TFSA yet again he now has $75,000 saved.
Then Joe sees an ad at another bank offering TFSA rates a half percent higher than he’s getting now. That would pay him an extra $375 per year. He decides to take action and withdraws the whole $75,000 and deposits it into a TFSA at the new bank.
Unfortunately, Joe does not do a “qualifying transfer,” which is when the TFSA contents are transferred directly from one TFSA to another without Joe ever handling the money. He just does the transfer himself. “What’s the difference?” you might ask. Qualifying transfers don’t count as a withdrawal and a contribution, but doing it yourself does count as a withdrawal and a contribution.
Those who are familiar with basic TFSA rules will realize that Joe has now made an over-contribution of $75,000. He will be penalized 1% or $750 each month, for a total penalty of $9000 for the year. The catch is that while Joe is allowed to withdraw his money, he’s not allowed to put it back again until the next calendar year (2021).
If Joe had made the same mistake back in 2009 when his balance was only $5000, his penalties for the year would only have been $600 instead of $9000. Anger over the size of TFSA penalties is bad enough right now. Without changes to either the TFSA contribution rules or to the way contributions are tracked to prevent mistakes, anger will grow along with the rising penalties.
You know what amazing penalties do to a system? Makes people NOT USE IT! Agreed that it's straight forward to keep track of this, but I still have people talk to me about a TFSA like it is their Chequing Account (i.e. deposit and withdraw when they like).
ReplyDelete@Big Cajun Man: I've heard some people talk of staying away. Too bad for them.
DeleteSay it ain't so, Joe.
ReplyDeleteThis is broken. The government cannot design a system that only a financially competent person can use.
ReplyDeleteIt has to work for financially illiterate persons as well.
@Anonymous: Agreed. It also needs to work for intelligent but inattentive people.
DeleteAgreed that rules are less than helpful and penalties are excessive, but I was glad to notice that Government does have some intelligent people who help Internet-connected citizens monitor their registered accounts via online access to http://www.cra-arc.gc.ca/myaccount/
ReplyDeleteYou can find there your current balance on taxes and registered accounts. Refreshingly handy.
AnatoliN, it's really not too handy -- it's only when financial institutions send an update to CRA... generally once a year.
DeleteI also don't have a problem with the current rules. It's meant for savings, not for moving money around all the time, and is certainly less restrictive than other registered savings accounts (e.g., the RRSP). People don't seem to have too much trouble with overcontributing and improper transfers there...
I find the "My Account" at CRA to be useful, but it's true that the TFSA information is usually out of date.
DeleteIt's true that people shouldn't be moving money in and out of TFSAs, but somehow that message hasn't got across to many Canadians (the "Savings Account" part of the name doesn't help). I think RRSPs were positioned much differently. Further, tax withholding on withdrawals may be the main reason people don't treat RRSPs as a savings account. Unfortunately, some Canadians took the government message that TFSAs are much more flexible than RRSPs too much to heart.