12 Costly TFSA Mistakes You Want To Avoid

Tax-Free Savings Accounts (TFSAs) offer Canadians a powerful tool for growing their savings without taxation. However, despite their apparent simplicity, TFSAs come with a set of rules and nuances that, if misunderstood, can lead to costly mistakes. These errors can result in penalties, lost growth opportunities, or unintended tax consequences.

This article highlights 12 common and potentially expensive TFSA mistakes that account holders should avoid. From contribution errors to investment missteps, understanding these pitfalls can help you maximize the benefits of your TFSA and ensure you’re using this valuable account to its full potential.

Over-contributing

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Contributing more than your allowed limit can result in a 1% penalty tax per month on the excess amount. This penalty continues until you remove the extra money or new contribution room becomes available. Always keep track of your contribution room and be careful not to exceed it, especially when you have multiple TFSA accounts.

Ignoring carry-forward contribution room

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If you haven’t maxed out your TFSA since 2009, you might have more room than you think. Unused contribution room carries forward indefinitely. Not taking advantage of this extra space means missing out on tax-free growth potential. Check your available room on your CRA MyAccount or latest Notice of Assessment.

Withdrawing and re-contributing in the same year

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When you withdraw money from your TFSA, you don’t get that contribution room back until the following calendar year. You could face over-contribution penalties if you re-contribute the withdrawn amount in the same year without enough available room. Wait until the next year to re-contribute unless you’re sure you have the room.

Holding foreign dividend-paying stocks

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While TFSAs shelter you from Canadian taxes, they don’t protect against foreign withholding taxes. For example, dividends from U.S. stocks held in a TFSA are subject to a 15% withholding tax that you can’t recover. Consider holding these investments in an RRSP or non-registered account instead.

Using your TFSA for day trading

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If the CRA determines you’re using your TFSA for day trading or running a business, they may tax all the gains as business income. This defeats the purpose of the tax-free account. Use your TFSA for long-term investing, not frequent trading.

Not naming a beneficiary

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Failing to name a beneficiary can make it harder for your loved ones to access your TFSA funds if you pass away. It could also lead to unnecessary probate fees. Name a beneficiary or successor holder (for spouses) to ensure a smooth transfer of your TFSA assets.

Misunderstanding TFSA transfers

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Withdrawing money from one TFSA and depositing it into another counts as a new contribution. Instead, request a direct transfer between institutions to avoid using up your contribution room. This is especially important if you’re switching financial institutions.

Not investing TFSA funds

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Simply using your TFSA as a regular savings account misses out on its growth potential. While keeping some cash for emergencies is fine, consider investing most of your TFSA funds in a diversified portfolio to maximize tax-free growth over time.

Borrowing to contribute

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While borrowing to invest can sometimes make sense in non-registered accounts, it’s generally not a good idea for TFSAs. The interest on loans used for TFSA contributions isn’t tax-deductible, and the risks often outweigh the benefits.

Not considering your TFSA in your overall financial plan

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Your TFSA shouldn’t exist in isolation. It should be part of your broader financial strategy. Consider factors like your tax bracket, short-term vs. long-term goals, and other savings vehicles when deciding how to use your TFSA. It might make more sense to prioritize RRSP contributions in some cases.

Assuming all TFSA investments are guaranteed

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The “savings account” in TFSA is misleading. TFSAs can hold various investments, including stocks and mutual funds, which can lose value. Don’t assume all TFSA investments are as safe as a savings account. Understand the risks of your chosen investments and ensure they align with your risk tolerance and goals.

Not adjusting investments as you age

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Many people set up their TFSA investments and forget about them. However, your investment strategy should change as you get older or closer to your financial goals. For example, a young person might choose riskier investments for long-term growth, while someone nearing retirement might want safer options.

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Joy Fadogba

Joy Fadogba is a passionate writer who has spent over a decade exploring and writing about lifestyle topics. With a fondness for quotes and the little details that make life extraordinary, she writes content that not only entertains but also enriches the lives of those who read her blogs. You can find her writing on Mastermind Quotes and on her personal blog. When she is not writing, she is reading a book, gardening, or travelling.