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TFSA Investors: Avoid Penalties With 2 Simple Rules

Christopher Liew, CFA
IMAGE OF A NOTEBOOK WITH TFSA WRITTEN ON IT
IMAGE OF A NOTEBOOK WITH TFSA WRITTEN ON IT

There’s more to a Tax-Free Savings Account (TFSA) than just growing your balance. Many TFSA investors are so overeager to earn big that they overlook the important aspects. Ignorance is no excuse, and the Canada Revenue Agency (CRA) could be at your door for mismanagement of your TFSA.

Over-contribution

Above all else, TFSA investors should be aware of the annual maximum contribution in the TFSA. The total accumulated contribution room as of 2019 is $63,500.

Let us assume that as of year-end 2018, you have contributed a total of $54,750. You have $8,750 left, which is the sum of $2,750 carried-over contribution and the $6,000 limit in 2019. If you withdrew $10,000 in January, then deposited the same amount in June, you have over-contributed $1,250 for 2019.

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The amount deposited or returned to the TFSA should have been $8,750 so as not to exceed $63,500. You have to wait for the next calendar year to return the $1,250. Remember that any excess amount contributed to the TFSA is subject to a 1% monthly penalty. Keep track of your TFSA contribution to avoid incurring unnecessary penalties.

Excessive trading

Some TFSA investors abuse the flexibility of the account by engaging in frequent trading. You’re allowed to invest in stocks, but do not use your TFSA for frequent buying or selling activities.

The CRA can check your trading activities throughout the year as well as the holding periods. Regular trading with very short holding periods will raise suspicions.

For example, an individual was brought to court by the CRA. The judge thought the primary intention was to trade stocks and make a profit. As a result, all earnings were ruled as business income and were therefore considered taxable income.

Stocks for TFSA investors

Dividend stocks like Cineplex (TSX:CGX) and Exchange Income (TSX:EIF) are ideal for TFSA investors. The stocks are among the highest dividend payers. There’s no need to engage in frequent trading.

Cineplex is a logical choice because the entertainment and media company is a dividend titan. For an investment of less than $25 per share, you’ll get to enjoy an annual dividend of 7.5%.

The company is Canada’s dominant movie chain. Blockbuster movies come few and far between lately, but movies still contribute 45% to Cineplex’s total revenue. With 70 million patrons trooping to the venues annually, the company expanded to non-movie ventures or recreational rooms where liquor and popcorn sales are increasing.

Aside from the Rec Rooms, Cineplex is finding new ways to diversify revenue streams. A partnership with Subway to operate its stores’ digital menu boards across Europe was established.

The aerospace and airline sector is not popular, but Exchange Income is popular to dividend investors. TFSA investors could realize better-than-market returns from the $1.24 billion industrials company. The stock is doing well so far in 2019 and is up 41.48% year to date.

Exchange Income pays an annual dividend of 5.6%, which is ideal to boost TFSA balances through dividend reinvesting. Revenue has been increasing by 30% yearly for five years, while income is growing by 22% annually. Future growth is certain with multiple contracts in the bag.

The most notable is the five-year contract awarded by the Canadian government with options to renew for five more years. Exchange Income will provide aerial surveillance services for Canada’s inland, coastal, and offshore waters.

Exchange Income will rack up more milestones as it expands to new regions. A company this stable and with a bright outlook deserves attention.

More reading

Fool contributor Christopher Liew has no position in any of the stocks mentioned.

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