It has become quite apparent that many of us did not really understand the rules of the new TFSA which was introduced in the beginning of 2009. Because of this lack of information, over 65,000 people have been affected by potential tax bills for over-contributing to their Tax Free Savings Accounts. To their surprise, a letter was received from Canada Revenue Agency, better known as CRA, letting them know that they may have to pay penalties on any excess contributions to their plan.

Let's look at some of the facts in order to help us all understand more clearly how these accounts work. The name Tax Free Saving Account (TFSA) does not truly fit the product, it leads to the misconception that you treat it like a typical saving account you use daily. Using it in that way will leave you with an unexpected tax bill. The TFSA should be used for long term goals where money is being deposited in the short term to achieve future plans. Besides a saving account, there are many various investment strategies for the TFSA such as GICs, stocks, bonds, segregated funds, mutual funds and preferred shares. A TFSA can be opened at a bank, trust company, credit union, through a financial advisor and investment brokerage firms.

For the moment, the maximum contribution that can be made in a year is $5,000 with the freedom of taking it out at any point tax free. Now what hasn't been very clear is that if you have maxed out on the full calendar amount and then use some of the money, you will have to wait until next year to invest it back into your TFSA. Let's say you put $5,000 into your TFSA in the beginning of 2009 and then 6 months later you took $2,000 out for car repairs. The earliest you would be allowed to deposit money back into the account, without a penalty, would be the 1st day of 2010. Otherwise that deposit would be considered an over-contribution, regardless if the TFSA was under the $5,000 limit for the year. Here is an example of over–contribution. Jan 1st 2010 you invest $5,000 in your TFSA and then on Feb 28th 2010 you use $4,000 to top up your RRSP. On May 30th 2010 you reinvest $4,000, which is a combination of your tax refund and bonus from work back into your account. Next year right after you have completed your tax return the CRA will send a letter stating you have over-contributed into your TFSA by $,4000. CRA will expect a cheque from you to cover the 1% penalty of $4,000 for each of the 7 months plus all capital gains from the over-contribution will be fully taxed. In a case like this if you can prove to the CRA, using a Request for Taxpayer Relief form, that your over-contribution was done in error it may be completely or partially waived.

Also be aware that transferring your TFSA from one institution to another in the same year that the deposit was made can be costly as it will be considered as an over-contribution. It's too bad that so many people have been affected negatively, by a product that is supposed to bring so much good to our society. I believe it is not the product per say, but the lack information that is being given before the TFSA's are being opened. If you want to open a TFSA or you are looking for more information please contact us.

- Article by Garen Lewis