Be Careful with TFSA Contribution Room

    

Your Tax-Free Savings Account (TFSA) contribution room, at any point in time, is made up of:

1.         your TFSA dollar limit ($5,000 per year plus indexation, if applicable);

2.         any unused TFSA contribution room in the previous year; and

3.         any withdrawals made from the TFSA in the previous year, excluding qualifying transfers.

 

      The delay in increasing your contribution room related to withdrawals from your TFSA within this formula can create unintended tax consequences if additional re-contributions are made later in the same calendar year.  These consequences will arise if, at any time in a calendar month, there is an excess TFSA amount in your account.  At this point, you are liable to a 1% tax on your highest excess TFSA amount in that month. This tax will be applied to each month going forward until the excess amount is removed.

 

      You have an excess TFSA amount if, at any time in a year, the total of all TFSA contributions you made in the year up to that time (other than a qualifying transfer or an exempt contribution) exceeds the total of your TFSA contribution room at the beginning of the year, plus any qualifying portion of a withdrawal made in the year up to that time. The qualifying portion of the withdrawal is the lesser of the amount of the withdrawal or the previously determined excess TFSA amount. Any portion of a withdrawal that does not reduce or eliminate a previously determined excess TFSA amount is not a qualifying portion of the withdrawal and cannot be used to reduce or eliminate any future excess TFSA amount that may be created.

For example:

 

• Mike, a 35-year-old Canadian resident, opened his TFSA on February 6, 2009, and contributed $5,000 on that date. On March 4, 2010, he contributed an additional $7,000. Since Mike’s unused TFSA contribution room as of the beginning of 2010 was only $5,000 (the TFSA dollar limit for that year), his contribution of $7,000 on March 3 resulted, as of that date, in an excess TFSA amount of $2,000.

 

• On May 17, 2010, Gilles withdrew $3,200 from his TFSA. The qualifying portion of this withdrawal is $2,000, since this is the maximum amount that eliminated the previously determined excess TFSA amount in his account.

 

• No part of the $1,200 portion of his withdrawal (the full amount of $3,200 less the qualifying portion of $2,000) could be used to reduce any future excess TFSA amount. In other words, if Gilles were to make a new contribution of $1,000 on July 6, 2010, this would result in an excess TFSA amount, as of that date, of $1,000, again subject to the 1% tax. (The $1,200 portion of the May 17, 2010 withdrawal does not create contribution room until January 2011.)

 

 

      As seen in this example, care must be taken in structuring withdrawals and subsequent contributions to a TSFA inside the same calendar year to avoid accidentally recreating excess TFSA amounts.