Monday, January 20, 2014

How to Rack Up a $7000 Tax Bill on Excess TFSA Contributions

There is a scary scenario that can arise with TFSA over-contributions where you can’t stop tax penalties from building up for an entire year. It involves a situation where your TFSA investments lose money. I’ve hunted through the Income Tax Act for a clause that deals with this case, but found none.

The scenario is best explained with a fictitious example. Ted was a big fan of Apple. When TFSAs first came on the scene, he made the maximum $5000 contribution in March of 2009 and put it all in Apple stock. Each January since then (including 2014), he has made a maximum contribution and bought Apple stock. His account now holds C$68,400 worth of stock.

Ted’s success with Apple gave him the confidence to try his hand at more active trading. He decided to open a TFSA at a different discount brokerage offering better active trader tools. He then withdrew his money from the first account and deposited it into his new account.

At this point, readers knowledgeable about TFSAs will realize that Ted has made a TFSA over-contribution of $68,400. However, Ted didn’t know this. Now he begins picking some stocks and buying shares. For the first few days, he doesn’t trade much, but his pace starts to quicken. He isn’t too bad at picking stocks, but commissions and spreads are eating him alive.

By the end of March 2014, some bad luck leaves Ted’s account balance at $8400, a loss of $60,000! Then Ted gets some bad news: he has been carrying a TFSA over-contribution of $68,400 for 3 months. The 1% tax each month will cost Ted $2052. But this is just the beginning of his troubles.

Ted immediately withdraws the remaining accounts assets ($8400). However, this still leaves an over-contribution of $60,000. But the account is empty. Ted has no other TFSAs to withdraw from to solve this problem. All he can do is wait for new TFSA contribution room next year to reduce his over-contribution.  The remaining 9 months of 2014 cost him 9% of $60,000, or $5400. In January 2015, his over-contribution disappears.  The total penalty is $7452.

It could be that CRA would use its discretion to waive penalties in such a case. And it could be that discount brokerages have safeguards to prevent people from making such a large over-contribution. But the fact remains that under the TFSA rules as I’ve read them, you can accrue taxes on over-contributions even when your TFSAs are all empty.


  1. Once January 1st of the next year rolls in, won't his withdrawal register and he no longer will be in an overcontribution scenario?

    However, if you simplify the scenario and someone overcontributes and looses everything, you'll have the same result and there will be an overcontribution which can't be withdrawn...

    1. @chuppe: You're right. The scenario I described will only cause penalties for one year. I'll fix the post. I'll have to think about plausible scenarios where the over-contribution lasts longer. The only one that comes to mind, as you say, involves a large over-contribution without any previous withdrawal, which doesn't seem very plausible.

  2. Kewl. That'd teach him not to sell his Apple stock.

  3. This is a good reminder to *transfer* TFSA accounts instead of withdrawing from one broker and contributing at another (the one exception is withdrawing at the end of the financial year and contributing in the new year).

  4. @BetCrooks: Of course, the lesson was different for those who sold Nortel stock near the peak.

    @CC: Good point. And the transfer paperwork is usually done at the financial institution at the receiving end of the transfer.