Why making a deliberate TFSA overcontribution is never a good idea


Jamie Golombek: CRA will tax any income or gain arising from a deliberate overcontribution at 100%

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A recent case involving a massive overcontribution into a tax-free savings account (TFSA) generated a variety of interesting questions from readers about how the resulting penalty tax works, and how best to minimize it. We’ll answer a couple of those questions below, but first let’s review the TFSA contribution (and overcontribution) rules.

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The TFSA annual dollar limit for 2023 is $6,500, but you may be able to contribute more than this amount if you have unused TFSA contribution room carried forward from prior years. If you’ve never contributed to a TFSA before, and have been at least 18 years of age and a resident of Canada since 2009, your cumulative TFSA limit is currently $88,000.

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Another point to keep in mind is that for those who have withdrawn funds from their TFSAs, the full amount withdrawn (that is, both your contributions and any tax-free income or growth) is added back to your contribution room beginning the calendar year after withdrawal.

If you mess up and overcontribute, there’s a penalty tax of one per cent per month for each month there is a TFSA overcontribution. The Income Tax Act, however, allows the Canada Revenue Agency the discretion to grant relief, and states the CRA may waive or cancel the penalty tax if the excess arose through “reasonable error,” and is corrected by the individual “without delay.”

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The case I wrote about last week involved a taxpayer who overcontributed to his TFSA to the tune of $639,308 and invested the funds into stocks. He was reassessed by the CRA and hit with an overcontribution tax of $6,393.08, which is one per cent of the overcontributed amount, relating to one month of overcontribution in 2020.

After he was reassessed by the CRA and told to immediately withdraw his excess contributions, the taxpayer declined to do so, preferring to wait until “the market improved.” At one point, his portfolio was down 50 per cent, which would be about $320,000.

Many readers wondered why the taxpayer didn’t simply withdraw the excess contribution “in-kind,” and then wait for the stocks to rebound outside his TFSA. There are two likely reasons.

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The first is that if the stocks inside the TFSA bounced back, the subsequent recovery would be tax free. If, on the other hand, the losing stocks were withdrawn “in-kind” from the TFSA, their cost for tax purposes, or adjusted cost base, would be set at the fair market value on the date of withdrawal, or $320,000. If the stocks fully recovered to $640,000, then a capital gain of $320,000 would result when the stocks were sold, half of which would be taxable.

But the bigger problem is that a withdrawal of the stocks in-kind, when they are worth only $320,000, would still leave a $320,000 TFSA overcontribution, which would generate an additional penalty of one per cent per month until enough new TFSA room is generated. Ignoring periodic inflation adjustments to the annual TFSA limit, it would take nearly 50 years for enough TFSA room to be generated to stop the penalty tax. If this sounds like an absurd result, it is. And it’s something I formally posed to the CRA at a conference in 2021.

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I envisioned a scenario where a taxpayer moved to Canada in, say, 2023, and opened a TFSA soon afterwards. Because he was previously a non-resident, the taxpayer’s TFSA contribution room for 2023 was only $6,500. Due to a misunderstanding of the rules, the taxpayer contributed $19,500 to his TFSA and invested it all in the shares of one company. Before he had a chance to withdraw his $13,000 overcontribution, the company went bankrupt and the value of the shares in his TFSA dropped to zero. How can the taxpayer stop the TFSA overcontribution tax, or request a waiver of the tax, if he can no longer withdraw the overcontribution? Or does he simply need to wait it out for two years, accruing the monthly penalty tax, until new TFSA contribution room opens up?

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The CRA responded that the taxpayer in this case is unable to withdraw any amounts from their TFSA and, therefore, “would be unable to mitigate the tax in this manner. Only new TFSA contribution room that becomes available to the individual in future years will serve to reduce the excess TFSA amount … (Since) the individual is unable to withdraw any amounts from their TFSA … (the CRA) would have no authority to waive or cancel the tax.”

Assuming the individual doesn’t make any additional contributions to his TFSA before 2026 and the TFSA dollar limit for each of 2024 and 2025 remained at $6,500, the excess TFSA amount would be reduced to $6,500 as of Jan. 1, 2024, and fully eliminated as of Jan. 1, 2025. The net result is that the individual would be liable for the one-per-cent monthly tax in 2023 and 2024. The individual could resume making TFSA contributions again in 2025.

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This is truly an absurd result and calls for a legislative fix. In the meantime, a taxpayer in this type of situation could apply for a remission order.

The other question some readers had was whether it ever makes sense to deliberately overcontribute to a TFSA in the hope that any penalty tax could be offset by the tax-free gain in the TFSA.

For example, let’s say Katy receives a hot tip about a penny stock expected to double within a month. She’s fully maxed out her TFSA contribution room, but deliberately overcontributes $500,000 into her TFSA in May 2023, and invests it all in that one stock. Sure enough, a month later, the stock doubles to $1 million inside her TFSA. She’s more than happy to pay a one-per-cent penalty tax of $5,000 on her $500,000 overcontribution.

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But Katy needs to know there’s a special anti-avoidance rule in the Tax Act that states that any income or gain arising from a deliberate TFSA overcontribution is considered to be an “advantage,” and is taxed at 100 per cent. Thus, making a deliberate TFSA overcontribution is never a good idea.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. [email protected].


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