TFSA over-contribution penalty: 1% per month on the excess amount

The CRA charges 1% per month on every dollar you contribute over your TFSA limit. Not annually - monthly. A $2,000 over-contribution costs you $20 every month until you pull it out.

The penalty starts the month after you over-contribute and continues until the excess is gone. So if you put in $1,000 too much in March, you owe $10 in April, another $10 in May, and so on. The clock doesn't stop until your account balance drops back to your contribution room.

How the CRA tracks your room

Your TFSA - the account where growth and withdrawals are both tax-free - gets contribution room each January. For 2024, that's $7,000 if you were 18 or older and a Canadian resident. Any withdrawals from the previous year also get added back as new room.

The CRA calculates this automatically based on what your bank reports. But their system runs behind by a few months. If you withdrew money in December and want to re-contribute it in January, the CRA might not have processed that withdrawal yet. Your online account could show less room than you actually have.

That lag is where most people get caught. You think you have $3,000 in room, contribute it, then get a penalty notice months later because the CRA's records showed you only had $1,500.

What happens when you over-contribute

You'll get a letter from the CRA demanding the 1% monthly penalty. The penalty is due by the end of the month following the month you owe it for. Over-contribute in March, penalty starts in April, payment is due by May 31st.

The penalty applies to the highest excess amount in each month. If you over-contributed $2,000 in March but withdrew $500 in April, you still owe 1% on the full $2,000 for March, then 1% on $1,500 for April.

TaxSplit.ca won't calculate penalty amounts, but it'll show your current TFSA room based on CRA data - which is what matters for avoiding this mess in the first place.

How to fix it

Withdraw the excess amount immediately. The penalty stops the month after your withdrawal brings you back within your limit.

You can't just leave the money and pay the penalty forever - well, you can, but it's expensive. That $2,000 over-contribution costs $240 per year in penalties. Better to pull it out and put it back next January when you get new room.

When you withdraw the excess, you get that room back the following year. If you over-contributed $1,000 and withdrew it, you'll have an extra $1,000 in room next January on top of the annual limit.

The catch with growth

Here's where it gets tricky: if the over-contributed money earned income while it was in the account, that growth stays behind when you withdraw the excess. You can only withdraw the amount you over-contributed by.

Say you put in $1,000 too much and it grew to $1,100 before you caught it. You withdraw the $1,000 excess, but the $100 in growth remains in your TFSA. That $100 doesn't count against your contribution room going forward - it's just stuck there until you withdraw other money first.

The penalty applies to the original over-contribution amount, not the growth. So you'd owe 1% monthly on $1,000, not $1,100.

If you over-contributed and aren't sure how much to withdraw, call the CRA. They'll tell you the exact excess amount based on their records. Don't guess - getting it wrong means either continued penalties or a second over-contribution.