The cost of overcontributing to your TFSA

If in January you contributed $5,000 to your Tax-Free Savings Account (TFSA), then withdrew $2,000 in August to meet an unexpected expense, does that mean you can contribute another $2,000 in November and stay within your limit? After all, your annual contribution room is $5,000.

If you answered, "Yes,î you are one of the reasons the Canada Revenue Agency (CRA) is sending out 76,000 letters to taxpayers who have overcontributed to their TFSAs and must pay the penalty. It is not about how much you have in your TFSA at yearend but about how much you have contributed. And withdrawals from your TFSA do not get added back to your contribution room until the following year.

According to the CRA, you have an excess TFSA amount  "at any time in a year as soon as the total of all TFSA contributions you made in the year exceeds the total of your TFSA contribution room at the beginning of the year plus any qualifying portion of a withdrawal made in the year up to that time.î (The qualifying portion of the withdrawal is the amount of the withdrawal or the previously determined excess TFSA amount, whichever is less.)

If you have overcontributed, you are liable to a tax of 1% on your highest excess TFSA amount in that month. In the above example, if you had mistakenly contributed that extra $2,000 on Nov. 1, your highest excess TFSA amount per month for November to December would have been $2,000. Your tax, therefore, would be $2,000 x 1% x 2 months, which is $40.

If, on Dec. 1, you realized your mistake and withdrew $2,000, you would pay one month's penalty. At the start of the new calendar year, your withdrawals from your TFSA are added to that year's contribution room.

"The proportion of individuals who received a [mailout warning] was less than 1% of the total number of TFSA holders,î the CRA's Philippe Brideau told the Vancouver Sun.  "This figure is significantly lower than the 1.5% who received proposed TFSA returns in the previous contribution years. While there are instances of misunderstanding, it is apparent that the vast majority of contributors understand the rules.î

By the end of the 2011 tax year, 8.2 million Canadians had opened TFSA accounts, which have more than $60 billion in assets.