Tax-Free Savings Accounts not so Tax-Free After All

Tax-free savings accounts seemed like such an easy answer for homebuyers and homeowners when they first came out in 2009. Unlike RRSPs, the traditional method of saving for a home, with a tax-free savings account you can contribute as much as you want, up to $5,000 a year, take it out whenever you want, and use it for a mortgage, to help pay off a home equity loan, or anything else that you need – and all of it is tax-free! But, as many people who did just that in 2009 just found out last year, it’s not that easy and if you’re not careful with your TFSA, it could be something that really is too good to be true.
That was the case with the 1.5% of people (72,786 of them in total) who received a letter from the Canada Revenue Agency last year, claiming that they had made an excess of contributions and that they would be penalized 1% for every month they over-contributed. But that still makes sense, right? There is, after all, a very clear $5,000 per year maximum that’s allowed to be contributed, and if you don’t follow by those rules, you should expect to be penalized. But, most of these individuals were completely unaware that they had over-contributed because they were actually re-contributing to the account for funds withdrawn.
So for example, a homeowner has $10,000 in their TFSA, accumulated over 2 years. They take out $5,000 at the end of 2009 to help pay off their home equity loan. In early 2010, they then re-contribute that money back to the account, and make an additional $3,000 contribution to the account, not even coming close to the $5,000 maximum. So they should be free and clear, right? Well, not if you’ve read the fine print on the Canada Revenue Agency website, and not if you’re one of the individuals that received a letter in 2010. The problem comes with confusion between what the Canada Revenue Agency deems to be the actual maximum, and how those funds are divided when you contribute or re-contribute to your TFSA.
So why are the rest of us, those who didn’t receive a letter from Canada Revenue, just hearing about this now? Because the ombudsman’s office has been busy investigating the number of complaints and queries that have come in response to the letters and the penalties. Since that time the office has been busy conducting an investigation of its own and preparing a report detailing what’s going on. That report has now been published under the title “Knowing the Rules” by the Taxpayer Ombudsman. But even getting the report has been a bit of a hassle, as the CRA has been busy always updating the information on its website, making it a bit more confusing for those trying to sort through it all; and training TFSA staff in policies and procedures. All of this seems to be adding to the frustration of those who are already so confused.
So what comes of it all? After “Knowing the Rules” was published, outlining ways the CRA could improve its services and make the rules of TFSAs much more clear, the CRA has responded. In a press release, the CRA has welcomed the report as the opportunity to identify areas in which Canadian consumers need to be better served. In the release, the CRA also included helpful tax tips and information, as well as links and contact info for financial institutions, as well as relevant newspaper articles from around Canada.