The issue of excessive contributions to tax-free savings accounts (TFSAs) has become a notable concern, driven by the enthusiasm of contributors. While there are improvements needed in the system for keeping individuals informed about their TFSA contribution room, it is crucial for TFSA holders to take greater responsibility for their actions.
A penalty of 1 percent per month is imposed on excess funds added to a TFSA, resulting in a substantial financial burden. According to Canada Revenue Agency (CRA) data, overcontribution penalties amounted to $132.6 million in 2022, a significant increase from $41.7 million in 2019 and a 38 percent rise from $96.2 million in 2021.
The average penalty in 2022 was $1,461.18, reflecting an upward trend from $1,239.02 in 2021, $1,063.72 in 2020, and $885.32 in 2019, indicating a concerning pattern. This pattern highlights the ongoing confusion among individuals regarding the workings of TFSAs.
One contributing factor to this issue is the tracking of TFSA contributions by the government. To ascertain contribution room, individuals must access their online CRA My Account or call the CRA tax information phone service. 1-800-267-6999. The information includes the current year's amount and unused room from previous years but is not updated throughout the tax year. It is only updated at the beginning of the year. It is therefore crucial for individuals to track their contribution amounts throughout the year.
Managing multiple TFSAs poses an increased risk of inadvertent overcontributions. Some individuals with multiple accounts may misunderstand how contribution limits apply, as the limit applies to all TFSAs collectively, not on a per-account basis.
A recent CRA report for the 2020 tax year revealed 16 million TFSA holders with 24.3 million accounts. While the average number of TFSAs per account holder is reasonable at 1.5, there are cases where individuals have accumulated 10 or more TFSAs.
Another way to mitigate the risk of overcontributions, a TFSA investor should wait until the next year before recontributing funds withdrawn in the current year.
In conclusion, the substantial size of TFSA penalties suggests significant overcontributions. Regular monitoring of TFSA room and contributions is essential, especially for those making automatic contributions and occasional lump-sum contributions. If notified of an overcontribution, immediate withdrawal is recommended, along with consideration of setting aside funds to cover the penalty. In addition, working closely with a financial advisor can help reduce these risks, as they have the tools and knowledge needed, to avoid these situations.
