Yahoo Finance 4 common mistakes Canadians can make with their TFSAs — and how to avoid them
Tax-Free Savings Accounts, or TFSAs, have become an increasingly popular choice among Canadians since they were first introduced in 2009, and it’s not hard to see why: TFSAs are a flexible yet powerful registered investment account that allows you to save and grow your money tax-free.
But just like with any financial tool, if you’re not using the account correctly, or you don’t fully understand all of its benefits, you may be leaving money on the table.
In collaboration with Fidelity, here’s a closer look at how you can avoid some of these all-too-common mistakes and seek to ensure you’re making the most of your TFSA.
1. Using a TFSA as a traditional savings account, rather than an investment account
Don’t let the name fool you: a TFSA isn’t a savings account, it’s a tax-free investment account—and that’s a very important distinction. Sure, you can hold cash in your TFSA and get a low interest rate return (typically around 1%), but these accounts were intended to do so much more. One of the biggest mistakes Canadians can make with their TFSA is using it as a mere savings account, without realizing they have a variety of investment options at their fingertips to help maximize their potential returns.
For instance, you can use your TFSA to invest in individual stocks and bonds, exchange-traded funds (ETFs) and mutual funds. And, when it comes to returns, these investment vehicles may give your TFSA more upside than merely using it to hold cash.
Better yet, these types of investments allow you to take advantage of the true power of your TFSA, which is found in two little words: “tax-free.” Since any returns in your TFSA are protected from income tax, that means your investments can compound tax-free over time. That also means no capital gains tax when you sell your investments, no taxes on any dividends or interest you receive, and withdrawals from your TFSA are tax-free.
Concerned about investment risk? Fidelity All-in-One ETFs make it easy to find a diversified investment solution that may align with your risk tolerance, investment objectives and fit nicely within a TFSA.
2. Not properly keeping track of contribution room
While contributing to a TFSA is fairly straightforward, it’s crucial to keep track of your contributions. That’s because TFSAs come with annual contribution room limits, meaning there is a maximum amount you’re allowed to contribute to the account in a year. If you over-contribute, this could result in a 1% penalty per month on the extra amount until it's withdrawn. Accidentally over-contributing can be a costly mistake—but, luckily, it’s a preventable one.
Your annual contribution room doesn’t disappear if you don’t use it; instead, it accumulates over time, and your contribution limit can be carried forward to use in future years. Meaning if you didn’t contribute the maximum amount last year, you’ll have extra room to “catch up” this year. Seems fairly straightforward, right?
If you have multiple TFSA accounts, or withdraw funds, however, it becomes a bit trickier to keep track of your current limits. Contribution room is added back when you make a withdrawal—so if you withdraw $1,000 from your account, for example, your contribution limit will eventually go up by $1,000, but this doesn’t happen right away. Instead, you have to wait until the beginning of the next calendar year (aka the following January) for that contribution room to get added back.
To make things easier on yourself, consider creating a simple spreadsheet to keep track of your annual contributions and withdrawals. If you ever do lose track though, don’t fret, you can verify your current contribution limits by logging into My Account on the CRA website.
3. Forgetting you can use a TFSA for short-term investment goals too
Unlike other registered accounts, like a Registered Retirement Savings Plan or the new First Home Savings Account, TFSAs offer a ton of flexibility when it comes to growing your savings. As a result, these accounts aren’t just useful for saving towards specific long-term events like retirement or a new home—you can also use them to save for shorter-term goals, like a new car or your next vacation.
The longer your money stays invested, the better you’ll be able to take advantage of the potential for tax-free compound growth. And remember, when you make a withdrawal (which you can do at any time), there’s no tax to pay. Withdrawals aren’t considered taxable income, which means they generally shouldn’t trigger government benefit clawbacks or impact tax credits.
So, while you should use your TFSA as an investment vehicle to allow you to compound your money tax-free according to your particular time horizon, risk tolerance and investment objectives, you’ve also got the flexibility to use it however you please.
4. Attempting to go it alone
When it comes to investing, knowledge is power. The more you learn about the ins and outs of how TFSAs work, the better chance you’ll have of avoiding these common mistakes and others. And while financial products can be complicated – particularly if you’re a new investor – you don’t have to navigate them alone.
Working with a financial advisor can help you to get a TFSA set up and answer any questions you may have. Once you’re ready to invest, Fidelity offers a range of ETFs and mutual funds you can use within your TFSA to help you reach your financial goals.
Interested in how you can make the most of your Tax-Free Savings Account? Visit Fidelity.ca to learn more.
This article has been sponsored by Fidelity Investments Canada ULC.
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