TFSA Mistakes to Avoid: Learn From Others

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Dividend Earner

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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.

Avoid 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 contribution allowance start 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 really 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 obviously 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.

wdt_ID Year Yearly Limit Cumulative 5% Growth 10% Growth Dividend Earner Spousal
1 2009 5,000 5,000 5,250 5,500 Not Tracked Not Started
2 2010 5,000 10,000 10,762 11,550 Not Tracked Not Started
3 2011 5,000 15,000 16,550 18,205 Not Tracked Not Started
4 2012 5,000 20,000 22,628 25,525 Not Tracked Not Started
5 2013 5,500 25,500 29,534 34,128 $41,742 Not Started
6 2014 5,500 31,000 36,786 43,590 $52,820 Not Started
7 2015 10,000 41,000 49,125 58,949 $56,307 Not Started
8 2016 5,500 46,500 57,356 70,984 $70,200 Not Started
9 2017 5,500 52,000 65,999 84,034 $78,900 $13,308
10 2018 5,500 57,500 75,074 98,487 $96,937 $58,818
11 2019 6,000 63,500 85,128 114,986 $129,467 $82,596
12 2020 6,000 69,500 95,684 133,030 $153,993 $95,906
13 2021 6,000 75,500 106,769 152,933 $181,601 $113,194
14 2022 6,000 81,500 118,407 174,827 $183,031 $144,633
15 2023 6,500 88,000 131,152 199,459 $217,738 YTD $167,963 YTD
16 2024 7,000 95,000 145,061 227,105
17 2025 7,000 102,000 159,664 257,516
18 2026 7,000 109,000 174,997 290,967
19 2027 7,000 116,000 191,097 327,764
20 2028 7,500 123,500 208,526 368,791
21 2029 7,500 131,000 226,828 413,920
22 2030 7,500 138,500 246,044 463,562
23 2031 7,500 146,000 266,221 518,168
24 2032 7,500 153,500 287,407 578,235
25 2033 7,500 161,000 309,653 644,308
26 2034 7,500 168,500 333,011 716,989
27 2035 7,500 176,000 357,536 796,938
28 2036 7,500 183,500 383,288 884,881
29 2037 7,500 191,000 410,327 981,620
30 2038 7,500 198,500 438,719 1,088,032
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 (ETF) 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. In fact, 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 … In fact, 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. In fact, 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 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. In fact, 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.