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TFSA 2020: Contribution Room and Over-Contribution Penalties

The Tax-Free Savings Account (TFSA) was introduced for Canadian residents in 2009. You can hold mutual funds, bonds, equities, and also cash in your TFSA. It is a flexible savings account in which the interests, dividends, or profits you earn on your investments are not taxed and can be withdrawn tax-free.

TFSAs provide major benefits when it comes to saving on taxes. It is a tax-sheltered plan and you can withdraw your savings anytime you want. You can have more than one TFSA at any point in time depending upon your financial goals. For example, whether you want to save for your kid's college, buy a car or start saving for retirement, you can have different TFSAs for each. 

You are eligible to own a TFSA if you are 18 years or older and are a resident of Canada. There is a certain limit to the amount of money you can contribute to your TFSA account. The maximum amount that you can deposit in a TFSA is called your contribution limit and this limit is different for every individual depending on when you could start allocating funds to the account. 

The annual TFSA contribution limit in 2009 was $5,000. This was increased to $5,500 in 2013 and remained the same till 2018 except in 2015 when the limit was increased to $10,000. The 2020 contribution limit is $6,000 while the cumulative contribution room is $69,500. 

You start accumulating the TFSA contribution room each year, even if you don’t file an income tax or benefit return or open an account. Any unused contribution for one year can be carried forward to the next year and any withdrawal will also be added back to your account in the following year. 

For example, if you contribute $5,000 in the year 2020 and you withdraw $1,000 from the account then you can re-contribute this additional $1,000 at the start of 2021. 

Calculating your TFSA contribution room 

According to DividendEarner, your TFSA contribution space starts accumulating once you turn 18. The amount that you can contribute is based on your accumulated limit and how much you have already contributed. 

According to CRA, the TFSA Contribution Room is the total of:

  • The annual dollar limit of the year
  • Unused TFSA contribution from the previous year and
  • Withdrawals made from the previous year

For example, if you turned 18 in the year 2009 and you have never contributed towards your TFSA to date, your contribution room will be the addition of annual limits from that year till 2020 i.e. $69,500. 

Now, if you have turned 18 in 2020, your contribution limit is $6,000. If you invest $4,000 then you have only $2,000 contribution space left in the current year. Consider that you could not contribute the rest of the amount this year, then the remaining $2,000 will be carried forward and added to your 2021 contribution limit.

Note that interest earned or any capital gain you receive on your investments will not affect your contribution space. 

Over-contribution and how to fix it?

When you over-contribute in your TFSA, you have to pay a penalty. To avoid over-contributing in your account you should calculate the amount of contribution you can make at the beginning of the year. 

According to advisorsavvy, when you over-contribute in your account, you receive a notice from the Canada Revenue Agency where you are asked to withdraw the funds and complete a form to submit payment for the accrued tax penalty. 

The tax penalty will be 1% of your excess amount, to be paid monthly. For example, if you over contribute $1,000 in the year, you pay a penalty of $10 every month till the excess amount sits in your account. 

To correct your over-contribution, you have to follow a very simple procedure. You can contact your financial institution to withdraw the excess amount and send the overpayment letter back as soon as possible.

In case you over contribute and do not withdraw the excess amount then that contribution will be carried forward to the next year. For example, your available contribution limit is $6,000 and you invested $7,000 in your account. If the money stays in the account, after paying a 1% penalty for the rest of the year, this over-contribution will be adjusted in the next year’s contribution room. 

TFSAs are an exceptional investment account because of the flexibility they offer. While you need to be aware of the contribution limits each year, it is easy to calculate, making them ideal for holding a variety of investments. 

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