Despite a year-long campaign to clear up confusion surrounding how much Canadians can contribute to their tax-free savings accounts (TFSAs), it seems many of us are still getting it wrong. This year, the Canada Revenue Agency (CRA) sent well over 100,000 letters to account holders telling them they overcontributed in 2010 and will have to pay a penalty. [Also see: Tax Free Savings Account (TFSA) Ideas]

If you’ve received one of these letter, or are at all confused about TFSAs, read on.

How much can you contribute?
Every Canadian aged 18 or older can put up to $5,000 per year into their TFSA. If you don’t use your $5,000 of contribution room in any given year, it can be carried forward for future years. For example, if you were 18 or older in 2009 (the year TFSAs were introduced), and you’ve never contributed to a TFSA, you can put up to $15,000 into your account this calendar year.

That sounds straightforward enough, and for most people, it is. For most, the confusion starts when they decide to withdraw money from their account. If you make a withdrawal from your TFSA, that withdrawal amount is added to your available contribution room as of January 1 of the following calendar year—not the current year.

Because this is still tripping up so many of us, let’s look at an example. Let’s say you’re contribution room for 2011 is $5,000 (because you’ve been dutifully contributing the maximum amount since 2009), and you’ve so far contributed $4,500 this year. In August 2011, you decided to withdraw $1,500 from your account. Your contribution room for 2011 remains $5,000, which means you can contribute at most another $500 this year. If you use all of your contribution room for 2011, your contribution room for 2012 will be $6,500 ($5,000 plus the $1,500 you withdrew in August 2011).

What happens if you’ve overcontributed?
If you get a letter from the CRA telling you that you’ve overcontributed, you’ll have to pay a penalty of 1% per month on the excess amount. The penalty stops accruing once you have either withdrawn the excess amount from your account or accumulated more contribution room, so you’ll want to withdraw that excess amount as soon as possible.

If you get a letter from the CRA and you don’t think you’ve overcontributed, ask yourself these two questions.

1. Do you have TFSAs at more than one financial institution? If you do, are you sure that the combined amount in these accounts is within your contribution limit? This is a simple mistake that many of us have made.

2. Did you transfer your TFSA from one bank to another? If you did, check that both banks handled your transaction as a qualifying transfer, not as a withdrawal and new contribution. After all, banks make mistakes too. If you held onto the money in a regular bank account or non-TFSA investment for any amount of time, that’s not a qualifying transfer. You’ve withdrawn the money and made a new contribution. Check the rules carefully at the CRA website.

If you’re still not sure how you’ve overcontributed, your best bet is to contact the CRA to find out what’s going on.