Calculating your 2012 TFSA contribution (October 2012)

Earlier this year, a major Canadian bank undertook a survey to determine just how many Canadians were taking advantage of the opportunity to earn investment income on a tax-free basis through a Tax Free Savings Account (TFSA). The survey results showed that just under half—47% to be exact—of Canadians eligible to do so had a TFSA, showing that the TFSA initiative has clearly been taken up by a significant number of Canadian taxpayers. The corollary, however, is that over half of Canadians have not, for whatever reason, seen fit to put money into such a plan. The failure to do so is unfortunate, as TFSAs, as a savings vehicle, combine tax advantages with an unparalleled degree of flexibility.

The general rules respecting TFSAs, which have been available to Canadians since January 1, 2009, allow an individual to put up to $5,000 into a TFSA in each calendar year. To the extent that contributions made during a year fall short of the $5,000 limit, any such shortfall is carried forward and added to the next year’s contribution limit. So, for example, a taxpayer who contributed $2,000 to a TFSA in 2011 would be allowed to contribute up to $8,000 in 2012, with the $8,000 contribution limit for that year representing $3,000 carried over from 2011 plus the usual $5,000 allowable contribution for 2012. A taxpayer who has never contributed funds to a TFSA is able to contribute up to $20,000 in 2012, the $20,000 figure representing a total of $15,000 of carryforward amounts from each of 2009, 2010, and 2011, plus the usual $5,000 contribution amount for 2012.

While no deduction is permitted for amounts contributed to a TFSA (unlike, for instance, contributions made to an RRSP), investment income earned by funds contributed to that TFSA are not taxable, either as they are earned or when they are withdrawn. Withdrawals, of either original contributions or of investment income earned, can in fact be made at any time and for any purpose, free of tax. Where withdrawals are made, the amount withdrawn can be re-contributed to the TFSA, but not until the year following the year of withdrawal.

Some of the failure of just over half of Canadians to utilize a TFSA as a savings (and tax-saving) vehicle may be attributable to a measure of confusion which arose during the first year TFSAs were offered, and which led to some taxpayers being assessed a penalty tax. The confusion likely arose in some measure from the name Tax Free Savings Account, which led taxpayers, not unreasonably, to treat their plans in the same way they would a savings account, making repeated deposits and withdrawals over the course of the year, without necessarily keeping track of the amounts which were going into and out of the plan. Many of the taxpayers who treated their plans in this way inadvertently went offside with respect to the TFSA rules, contributing more than the allowed $5,000. Others misunderstood the withdrawal/recontribution rules, and made a withdrawal from their TFSAs early in the taxation year and then recontributed the withdrawn amount later in the year, in the mistaken belief that recontribution at any time was permitted. While the Canada Revenue Agency (CRA) eventually provided administrative relief to taxpayers who went afoul of the rules simply because of a misunderstanding of those rules and did not levy the usual penalty tax in such situations, the confusion started the program off, to an extent, on the wrong foot.

Another area that has given taxpayers difficulties is that of transfers between institutions. As is the case with RRSPs, it is possible to open a TFSA at virtually any financial institution in Canada, and quite often incentive interest rates or bonuses will be offered to attract TFSA deposits. Consequently, it wouldn’t be unusual for a taxpayer who has TFSA funds on deposit at one institution to decide that a better deal can be obtained from a different financial institution. Where a taxpayer moves funds from a TFSA at one financial institution to a TFSA at another such institution, there is no impact on the taxpayer’s current year contribution room, as long as the transfer is what is known as a “qualifying transfer”, meaning a transfer done directly between those two financial institutions. Such transfers can, however, take a bit of time to execute and the taxpayer may well feel that it would be faster and easier to simply withdraw the funds from the TFSA at the first financial institution and then deposit them him or herself into the TFSA at the second one. However, that course of action has some unwelcome consequences. Where a taxpayer withdraws funds from one TFSA and then contributes that amount to another TFSA, the subsequent contribution will be considered a new contribution that will reduce, and may even exceed, the taxpayer’s TFSA contribution room for the year. And, where TFSA contribution room is exceeded, the result will be the imposition of a penalty tax of 1% per month of the excess.

The deadline for a current year contribution is December 31^st of the taxation year and that date is now less than three months away. There are two ways to find out one’s contribution limit for 2012. The first is by calling the CRA’s individual income tax enquiries line at 1-800-959-8281. For those with internet access, information on TFSA contribution room can be obtained by going to the CRA’s Quick Access service on its Web site at http://www.cra-arc.gc.ca/esrvc-srvce/tx/ndvdls/qckccss/menu-eng.html. In both cases, it will be necessary to provide some personal information, including figures from previously filed tax returns, for security reasons.

When deciding whether to make a TFSA contribution for 2012 and, especially, how much that contribution should be, consideration should be given to the following.

• If regular or periodic contributions have been or are being made to a TFSA throughout the year, it is a good idea to take the time to calculate one’s 2012 contribution room, to ensure that the limit won’t be exceeded. If that’s already happened, the best course of action is to withdraw the excess funds immediately, as a penalty tax will be assessed for every month or part month that those excess amounts remain in a TFSA.
• If TFSA funds have been moved from one financial institution to another, and that transfer was effected by means of a withdrawal and deposit, rather than a direct bank-to-bank transfer, remember that those funds will be counted as a current year contribution. If the withdrawal/recontribution has resulted in an excess contribution for the year, those excess funds should be withdrawn as soon as possible.
• Those who are considering making a withdrawal from a TFSA within the next 6 months or so, perhaps to pay for a winter vacation or to make a 2012 RRSP contribution, should consider making that withdrawal before the end of the calendar year. TFSA funds which are withdrawn before the end of 2012 can be re-contributed beginning January 1, 2013. Where funds are withdrawn after December 31, 2012, no re-contribution of those funds will be allowed until January 2014 at the earliest. Even if a re-contribution isn’t necessarily planned, accelerating the withdrawal into 2012 will provide the taxpayer with increased flexibility should a re-contribution become possible. As well, since there are no tax consequences to withdrawing funds from a TFSA, it doesn’t matter, from an income tax perspective, whether that withdrawal is done in 2012 or 2013.

Finally, taxpayers who have difficulty calculating their TFSA contribution room for 2012, or are unsure of just what their position for 2012 is, can review the information on TFSAs provided on the CRA Web site at http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/menu-eng.html, or can contact the CRA’s Individual Enquiries line at 1-800-959-8281 for more individualized information.