What to do When You Over Contribute to Your TFSA
If you want to save money tax-free for your future, the TFSA is for you. It is a great way to let your money grow and mature in a tax-free manner. However, don’t just throw money in there without a care or thought, or you will find yourself in some trouble with the CRA. This is because there are TFSA contribution limits every year and if you over contribute; you will be on the hook for a penalty, which could potentially cause financial problems for you. However, if you find yourself facing a penalty due to over contributing to your TFSA, don’t panic too much, there are a few things you can do to keep the penalty manageable or even potentially get rid of it altogether.
What is a TFSA?
However, before we dive into what to do when you contribute too much to your TFSA, we need to make sure everyone knows what a TFSA is. A TFSA (which stands for Tax-Free Savings Account) is a flexible way for you to save money in a tax-sheltered manner. While the contributions are not tax deductible for income tax like an RRSP, you get the huge benefit of being able to withdraw this amount at any time without having to pay taxes. This is great as it allows for help with both short and long-term goals and allows for money to grow and compound faster thanks to the fact it is tax-free. Also, remember that a TFSA doesn’t have to be a cash savings account (despite its name), so feel free to hold investments in your TFSA account as well.
The TFSA is also a fairly new account and has only been offered since 2009. So, many people might not be taking advantage of it when they definitely should be. The contributions for the TFSA are different from the RRSP with the fact that everyone has the exact same limits, no matter how much money they make. The limits have changed a bit over time, but over the last few years, individuals are able to contribute $5,500 each year to their TFSA. Of course, if you have unused contributions in previous years, that can carry forward and allow you to contribute more than the $5,500 yearly limit. Also, if you just open a TFSA now, you will have all of the unused room from the previous years as well.
For further information about your TFSA, click here.
What Penalties Will You Face if You Over-Contribute?
With that taken care of, let’s finally begin to look at the penalties a person could face if they over contribute to a TFSA. The excess amount you contribute to a TFSA is subject to a 1% per month penalty tax. So if you over contributed by $2,000 in a given year, you would be paying a penalty of $20 a month as long as the excess amount is still in your account.
Unlike an RRSP (where individuals are given a $2000 grace amount), any amount that you contribute over the limit will be subject to the penalties, so be sure to watch how much you are contributing every year, as there is no wiggle room.
Overcontributions to the TFSA are actually quite common because of one little rule that can often confuse people. When you withdraw from your TFSA, it increases your contribution room. However, this doesn’t occur until January 1st of the following year after your withdrawal. Because of this, many people contribute more the same year of their withdrawal, thinking that they have immediately created room when that contribution room doesn’t actually open up until the next year. Tens of thousands of people have over contributed because of this rule, despite how much the CRA has tried to make the rule common knowledge among the public.
What Options Do You Have If You Over-Contribute?
If you have a penalty to pay for over-contributing to your TFSA, there are a few different choices when it comes to what you want to do next. The options include simply paying the penalty or appealing to the CRA. We will first take a look at how you can go about paying your overcontribution penalty.
In order to pay your penalty, you need to file a special TFSA return (which is known as Form RC243) and to fill it out and send it to the CRA, along with your payment. The major key here is to act quickly. The faster the excess amount is removed from your account, the quicker the penalty is paid and the better off you will be.
Of course, you can also try and send an appeal to the CRA and see if they are willing to give you a break and waive the penalty. This request should include all of your personal information as well as a detailed look at what went wrong, how you are fixing it and why the over contribution took place in the first place. While there is no guarantee this will work, of course, it could be worth a shot. However, it can often take you upwards of a month or two to hear back from the CRA so if the penalty is small (which it hopefully is if you caught it soon enough), you might be better off just paying it. Because if you send in an appeal and don’t hear from them in a while, you could actually end up owing more as another month might have passed.
Watch out for the fake CRA telephone scam!
Always Remove Your Excess Contribution
People can choose whichever method is best for them, but either way, you should look to remove the excess contribution as soon as you can. Not only will this save you money if you are paying the penalty, but will also show the CRA that you are working to rectify the mistake you made, which could work in your favour if you are planning to appeal. Also, it wouldn’t be a bad idea to pay the penalty even if you are planning on appealing to get the penalty waived. If the CRA accepts your appeal, they could reverse the penalty payment amount and send it back to you.
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In order to prevent over contributing from becoming an issue going forward, be sure to always keep track of how much you are contributing and when. This is easily done by either automatically contributing a certain amount every month (to make sure you don’t over-contribute) or by simply contributing all of the $5,500 early in the year and then not having to worry going forward. It is completely up to you to ensure you aren’t over-contributing and if you are not careful, you could be stuck paying a hefty penalty.
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