TFSA Excess Contribution Penalties Ensnare Taxpayers
The Tax-Free Savings Account (TFSA) was introduced as a vehicle that would shelter investments from tax. Many tax payers are finding that instead of saving tax on investment returns, the TFSA is costing them money. These tax payers are now being charged penalties for the 2009 tax year to the tune of 1% per month for contributions to the TFSA accounts exceeding $5,000.
In some cases, the penalty could be hefty. For instance, let’s say a taxpayer opens a TFSA account at Bank A in early January and makes an initial contribution of $5,000. Later in the month, he hears that Bank B is offering a much higher interest rate for TFSA accounts. He withdraws the entire balance from the TFSA account at Bank A, opens a new account at Bank B and deposits the $5,000. Now, according to the TFSA rules, he has an excess TFSA amount of $5,000 for January. If the taxpayer maintains the account balance at Bank B until the end of the year, he has an excess TFSA amount of $5,000 for each month of 2009. The penalty: $5,000 * 12 * 1% = $600. In a typical TFSA savings account, our taxpayer would have earned about $100 to $150.
Many taxpayers are understandably mad to find that they have been tripped by TFSA rules. They are taking to the Internet to make their displeasure clear with the Government. There are petitions floating around asking the Government of Canada waive all TFSA over contribution penalties resulting from “unintentional errors” and “general misunderstanding” of the workings of the TFSA. It is hard not to feel some sympathy for the plight of taxpayers who inadvertently made excess contributions to the TFSA but a blanket waiver would be unwise.
First, it should be pointed out that TFSA rules were clear even before financial institutions started offering these accounts (See post FAQ on Tax-Free Savings Accounts dated December 1, 2008). It is hard to make the case that CRA rules were somehow unclear as some are trying to. Second, clients have a legitimate complaint if their financial institution or financial advisor made no effort to caution them not to exceed the TFSA contribution limit in cases where contributions and withdrawals were made to the same account. (It should be pointed out here that ING Direct posts a notice that says “Please double check your TFSA contribution limit to avoid exceeding it. This means adding up all the contributions you’ve made to TFSA accounts at ING DIRECT and your other Financial Institutions”.) But, this is a matter that should be taken up with the institution or advisor, not the Government. Finally, taxpayer relief provisions already allow the CRA to forgive interest when the taxpayer is experiencing financial hardship. For all these reasons, waivers should only be considered on a case-by-case basis.