A federal effort to encourage Canadians to save more in a special account has led to frustration and anger among those who didn’t understand the complex rules.
Thousands of people received letters from the Canada Revenue Agency this month, saying they owed extra tax of 1 per cent a month on over-contributions made to a TFSA (tax-free savings account). They have until June 30 to pay the tax or risk penalties.
I’ve heard from dozens of readers since my Saturday column about the TFSA confusion
. Most are facing tax bills that far exceed their tax-free income.
The $5,000 annual limit for contributions was widely known. However, some people failed to realize that a TFSA was not a regular savings account, allowing easy transfers in and out. They had to wait until the next year to replace money that had been withdrawn.
The rules on excess contributions were explained at the government’s website, www.tfsa.gc.ca
. But not everyone checked the rules before opening an account.
“Withdrawals from a TFSA in a given year are not added back to an individual’s contribution room until the following year,” says a federal finance official.
“Without such a rule, it would be very difficult to verify whether a given contribution is within the individual’s TFSA limit.”
Many people told me they had relied on their financial institutions to give the whole story about TFSAs, but received only partial information.
One reader opened an account at her bank’s encouragement last year. She moved in $21,000 from her chequing account, thinking she could escape tax on the interest earned on the first $5,000.
She ended up with a massive tax bill of $1,240 for her excess contributions in 2009. Now she’s asking why the bank didn’t warn her that she was over the limit.
Another reader, also pitched to open a TFSA, used it to save for wedding expenses. She received a $200 tax bill and after calling her bank, was told the withdrawal rules were not clearly known until a few months ago.
ING Direct was one of the first banks to attract TFSA contributions with an ad campaign that started before the Jan. 1, 2009, launch date.
“The government was quite slow out of the gate on getting financial institutions the forms and information required to service TFSAs,” says ING spokeswoman Lisa Naccarato.
“This could explain some of the lack of information when TFSAs first became available.”
Some readers received tax bills after transferring TFSAs from one financial institution to another. You can do transfers without penalty, but only if you ask a financial institution to move investments directly from one account to another.
If you close an account with $5,000 at one bank and deposit $5,000 at a different bank in the same year, you’ll be taxed for making an excess contribution.
“The main message that Canadians need to know is that TFSAs are registered products and there are rules associated with transferring funds,” Naccarato says. “They need to view them as similar to RRSPs, where a specific process is followed for transfers.”
In my last column, I mentioned two examples of readers making transfers within a bank that were ruled offside. One moved a TFSA from a TD Waterhouse discount brokerage account to a TD Canada Trust bank account and another did the opposite.
“TFSA issues appear to be varied and we have a dedicated team working to figure out what’s happened in each case and how to fix it,” says Barbara Timmins, a TD Bank Financial Group spokeswoman.
“In cases where an internal transfer between TD Canada Trust and TD Waterhouse resulted in the contribution being mistakenly counted twice, we have committed to communicating the correct information to the CRA by June 30.”
It shouldn’t take almost 18 months from the TFSA launch date for clients and banks to learn the rules. Moreover, some people will have to pay more tax next year for errors made in 2010.
The federal government looks bad for rushing to launch a new tax shelter without communicating the risks of over-contributions and improper transfers. This could hurt its electoral chances if the fiasco isn’t fixed quickly.