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Tax-Free Savings Accounts (TFSAs) have lots of benefits, but there are a few common mistakes that could cost you money in penalties, unnecessary taxes, and missed opportunities to maximize your investment.
Mistake #1 Overcontributing to your account
Adding money above your contribution limit is one of the most common errors with TFSAs. You can over contribute in two different ways.
- Simply putting too much money in your account. Your contribution limits depend on how old you are and how much is already in your account. Adults over 18 receive a contribution limit every year – the limit for 2023 is $6500. Each year, you receive additional space, and any unused space from the previous year is carried forward.
For example, if you’ve been eligible for a TFSA since last year and haven’t contributed anything yet, your limit would be $12,500.
- You replace TFSA withdrawals within the same calendar year. While taking money out of your TFSA doesn’t decrease the overall contribution space, the space doesn’t get “re-added” until the following calendar year.
Example: You’ve contributed the maximum amount to your TFSA every year, including $6000 for 2021. In August, you withdraw $3,500 and then replace the money in October. Even though you are just replacing the money you withdrew for tax purposes, you’ve now contributed $9,500 for 2021 – $3,500 over your contribution limit.
It’s important to note the TFSA limits apply per person, not per account – so even if you have TFSA’s with multiple financial institutions, your limit stays the same. You can check your TFSA contribution limit on the CRA website.
Penalties: Contributing over your limit will cause you to incur a penalty tax from the Canada Revenue Agency (CRA). You will be charged 1% of the overage amount for each month that you’re over the limit. So, using the example above, if you left the $3,500 in your TFSA until January 2022, you would be charged $105 -$35 per month from October to December 2021.
Mistake #2 Not considering market gains and losses when assessing your contribution space
A TFSA is an investment, and as such, it can change in value depending on the market. Increases and decreases can make a big difference to how much, or little, you’ll be able to contribute.
Example: You initially contributed $6,000, and over time that investment decreased to $5,000. If you withdraw that $5,000, you will only be able to re-contribute $5,000, in effect losing $1,000 of contribution space.
The opposite is also true. If your original investment increases to $7,000 and you withdraw those funds, you will be able to re-contribute $7,000 in the future.
So, if you plan on the occasional withdrawal from your TFSA, but sure to consider the level of risk involved in the investments you choose.
Mistake #3 Naming your spouse as a beneficiary instead of a successor holder
A TFSA beneficiary receives the assets of the account tax-free upon the account holder's death. The successor holder becomes the new owner of the account.
Example: Let’s look at these two options on the event of your death.
- Beneficiary: Your TFSA would be closed, and a cheque would be issued to your spouse for the total amount in the TFSA plus any investment growth. The issue is that your spouse now needs to find a new, tax-free place to house those funds.
- Successor holder: Your spouse would be able to keep your TFSA intact, allowing the funds to continue to grow tax-free. Your spouse can be your successor holder even if they have their own TFSA, but they will not be able to contribute further to your account.
Mistake #4 Choosing investments that produce foreign income
Foreign dividends that pay into a TFSA are subject to withholding tax. In other types of investment accounts, you may be able to claim a foreign tax credit to offset the withholding tax deducted, but this is not the case with a TFSA.
Mistake #5 Choosing non-qualified investments
If you’re the type of investor who looks for “off-the-radar” companies, you should probably not include those investments in your TFSA portfolio.
Securities not traded through a recognized stock exchange risk being ruled ineligible for a TFSA.
Penalties: Look out! The fines for holding non-qualified investments are steep. The penalties are 50% of the investment value plus the loss of tax-free status for that investment. There may be further tax implications as well, depending on the investment.
A TFSA is a great way to save money, tax-free, and avoiding these mistakes will help you reach your saving goals more quickly, without any unpleasant surprises.
For more information, advice, and help with TFSA, book an appointment to talk to a member of our Alterna Wealth Team.
Updated: February 2023