TFSA Mistakes to Avoid: Learn From Others

Dividend Earner

Dividend Earner

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6 min read Affiliate Disclosure

The TFSA account is a powerful investment account.

It’s competing with the long-term champion RRSP account and is possibly a better account in the end when taxes come into play.

Along with the general investing mistakes to avoid, be aware of the mistakes below and you’ll be a step closer to a better financial posture.

TFSA Quick Primer

Simply put, the TFSA, or Tax-Free Savings Account, is a tax-free account where you can hold cash, bonds, GICs, mutual funds, ETFs and Stocks to name a few.

There is an annual contribution limit but it carries over and the contribution allowance starts in the year you turn 18. Slow and steady you can build a fortune – when done right.

6 TFSA Mistakes to Avoid

We all are at different stages of life but even if you are far from retirement (or financial independence), putting a little aside in a TFSA account for 30 years will do wonders.

Mistake #1 – Don’t use your TFSA as a Savings Account

The name is incredibly misleading. It should have been called a Tax-Free Investing Account instead of a Tax-Free Savings Account. Unfortunately, most Canadians put cash in the TFSA and that’s not how you build wealth.

You can save so much in taxes by investing in a TFSA account. There are also many ongoing discussions around choosing between a TFSA or a RRSP. The winner depends on your situation, just look at the infographic for help. 

Don’t use it to save cash and avoid being taxed a few pennies, it’s much better as an investment account to save thousands. Especially with the low interest rates we have.

In fact, inflation alone will destroy your cash savings. It’s transparent and you can’t see that but it’s a matter of the gas price at the pump going up faster than your savings.

As you can see below, investing will be a much better option to build wealth. Your emergency account should be in a high-interest savings account and the same goes for your house down payment.

TFSA Growth After 30 Years

Mistake #2 – Withdrawing and Contributing back in the same year

One of the greatest benefits to the TFSA is the ability to be able to contribute back in what you withdraw.

However, you need to wait until the following year to do so.

This is where the mistake happens. Contributing back the withdrawn amount in the same year is considered an over-contribution.

I know it doesn’t make sense. In this day and age, financial institutions should be able to properly account for this but I guess it’s a financial complication for reporting to the government across institutions.

The penalty is 1% per month on the over-contribution over and above the allowed amount for the year.

Mistake #3 – Avoid Over-Contribution

Know your annual TFSA contribution limits as it will help you avoid making an over-contribution mistake. 

Another good way to avoid the over-contribution mistake is to only have one TFSA account. You should be able to calculate and see your contribution for the year.

Do not attempt to over-contribute, and pay the interest while cashing in on a hot stock. The government also looks for that and will tax your full earnings like a taxable account.

Mistake #4 – Don’t open your TFSA at the Bank!

Don’t open it at the bank through the bank website. They are making it easy to open a TFSA account but all you will be able to do is buy mutual funds or put some savings.

Both of which should not be allowed. You don’t want mutual funds either; fees are too high and will eat your profits.

You need to open your TFSA account with a discount broker.

Each of the big banks has one but it’s separate from your banking. You have some extra hoops to go through to open your TFSA account. There are also non-bank discount brokers such as Questrade with some having lower fees and no-fee ETFs.

Even if you are not ready to buy stocks, avoid mutual funds and focus on exchange-traded funds (ETFs) like an S&P500 index ETF. They trade like stocks through a discount broker.

Mistake #5 – Don’t Day Trade from your TFSA!

Day-trading from your TFSA will be taxed. The Canada Revenue Agency (CRA) considers it operating a business, and in time the CRA will discover it.

You might not be identified in the first year or the second, but the computer algorithm will catch up and find you later. The CRA has been investigating high-profit accounts as a starting point.

Don’t take chances and avoid retroactive taxes. It’s not what you want either … There are no audit limits and they can go as far back as 2009. Imagine that!

To determine whether a TFSA is carrying on a business of trading, the CRA looks for the following conditions, although not exhaustive:

  1. The frequency of transactions;
  2. The length of time the stocks are owned;
  3. The investor’s level of knowledge and experience;
  4. The amount of time spent studying the markets and potential investments;
  5. Whether the stock purchases are financed by debt;

In short, keep your active trading to your taxable account if you do want to day-trade. It also doesn’t matter what you call yourself, it’s based on the CRA identifying your transactions as active trading.

Mistake #6: Skip Your TFSA If You Have Credit Card Debt

This is more of a personal finance rule but you should always pay your high-interest debt before you invest.

Beating the high interest rate of credit cards requires a stellar investment return. You need to take risks to beat the credit card interest rates and you could lose more money.

It’s just not wise money management.

TFSA Considerations

I don’t see US dividend stocks as a mistake but some people do.

A US dividend stock will be subject to a 15% withholding tax on the dividend paid but not on the capital gains.

It’s a small ding to your profit but not critical if the stock appreciation is good. I hold some low dividend yield US stocks for the total return and it outperforms many Canadian stocks.

Another point is to be careful how you initiate a transfer between institutions as doing it the wrong way could trigger a cash withdrawal from one institution followed by a cash deposit and cause you some grief.

I am sure in discussion with the CRA you could get it cleared but it’s time-consuming and stressful.