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One of the most attractive features of contributing to a tax-free savings account is the ability to subsequently withdraw as much money as you want, tax-free, whenever you want, and recontribute the funds withdrawn back to your TFSA, beginning the following calendar year.

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This feature makes the TFSA a great savings option for short- or medium-term goals, such as a wedding reception or a new roof. Contribute for a few years, allow the funds to grow unencumbered by tax, withdraw them tax-free to fund your savings goal and then recontribute those funds when available (so long as it’s not the same year as the withdrawal) to enjoy decades of permanent tax-free growth for life.

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For example, let’s say Jeremy graduated from school in 2024, started his first job and managed to set aside $7,000 after-tax in his TFSA each year for the past three years, totalling $21,000 of contributions. He invested in an S&P 500 exchange-traded fund, such that his TFSA is now worth about $29,000. He decides to withdraw the funds this month to help him buy a new car. The funds can be withdrawn tax-free, and next year (2027), Jeremy will be able to re-contribute the full $29,000 withdrawn in 2026, in addition to potentially contributing the 2027 dollar limit, projected to be $7,500 (but not yet confirmed by the Canada Revenue Agency).

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But this flexibility to withdraw and recontribute has also landed many taxpayers in hot water with the CRA when funds withdrawn are recontributed in the same calendar year and there is no unused TFSA contribution room available. Take the most recent case, decided earlier this month, involving a British Columbia taxpayer and her TFSA.

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The taxpayer’s troubles began on April 3, 2024, when she withdrew $27,000 from her TFSA, but recontributed it on May 9, 2024. As of December 31, 2023, the taxpayer’s unused TFSA contribution room was $29,843, and with $7,000 of new TFSA room opening up on January 1, 2024, she did not yet have a TFSA overcontribution, as she had $36,843 ($29,843 plus $7,000) of available room for 2024.

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But, that wasn’t the end of the story as the taxpayer withdrew a further $27,000 from her TFSA on September 6, 2024, and recontributed it four days later on September 10, 2024.

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The penalty for overcontributing to your TFSA is one per cent per month for each month you’re over your limit. In this case, for 2024, the taxpayer’s TFSA contribution limit was $36,843, but she contributed $54,000 in total in 2024 ($27,000 twice), meaning she was over by an excess of $17,157 ($54,000 minus $36,843), as her withdrawals wouldn’t get added back to her TFSA contribution room until the following year, 2025.

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As a result, the CRA charged the taxpayer an overcontribution tax for September, October, November and December 2024. It applied a penalty tax of one per cent each month on the $17,157 excess TFSA contributions, or approximately $172 each month for the four months in 2024 she had an overcontribution, for a total penalty tax of $686.

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The CRA also assessed the taxpayer a late-filing penalty as any taxpayer who overcontributes to a TFSA is supposed to self-report their overcontributions annually by filing the Form RC243, TFSA return by June 30 of the year following the overcontribution. Failure to file the RC243 on time comes with its own penalty of five per cent of the balance owing, plus one per cent of the balance owing for each full month that the return is late. In this case, the CRA charged the taxpayer a $34 penalty (five per cent of $686).