Since it was created 10 years ago, the TFSA has grown in popularity with Canadian investors. According to a study conducted by BMO, 69% of Canadians had a TFSA in 2018 — up from 56% in 2017.
To fully benefit from your TFSA, there are some mistakes you should avoid. While there are many, I present here three mistakes that you should especially avoid if you want to profit the most from your TFSA.
Exceeding the contribution limit
Be careful not to exceed the contribution limit in your TFSA. Many people go over their TFSA contribution limit without knowing it, and it is very costly.
If you exceed the limit, the Canada Revenue Agency (CRA) will charge you a penalty of 1% per month for any amount that goes over your total TFSA limit ($63,500 in 2019) until you withdraw the funds in excess. You will eventually get a letter from the CRA to notice you, but it can take a few months.
It’s important to track your contributions carefully and to take note of any withdrawals from your TFSA. A TFSA is not like an ordinary bank account. If you withdraw money from you TFSA, the amount you withdraw will be added to your contribution limit, but only the year after you make the withdrawal.
Holding cash in your TFSA
Although it is called a “tax-free savings account,” you shouldn’t hold cash in your TFSA. In a TFSA, you’ll never have to pay taxes on any money you put in it and on all the money you make from it. It is therefore not optimal to hold cash in a TFSA, since returns on cash are very low.
While its name can be misleading, you can hold any investments in a TFSA from cash, guaranteed investment certificates (GICs), bonds, stocks, ETFs, and mutual funds.
While you’ll make only about 1% a year in a daily savings account, you can get much more by investing your TFSA in stocks. There are many great stocks that will give you strong capital appreciation and that will also give you dividends which are entirely tax-free.
For instance, TD Bank (TSX:TD)(NYSE:TD) stock has risen by almost 13% since the beginning of the year. What is also great with a bank stock is that it pays high dividends, which are entirely tax-free in a TFSA.
TD will pay you a quarterly dividend of $0.74 per share, which gives a yield of 3.5% at the current price. So, with just the dividend, you get a much higher return than the interest you can earn in a savings account. TD is a very solid bank, so you don’t need to worry about your money. The dividend is very safe and increased regularly. Plus, the stock is a bargain.
Your TFSA can grow to a big amount if you maximize your contributions and manage your portfolio properly.
Holding U.S. stocks that pay dividends in your TFSA
A TFSA is not the ideal place to buy U.S. stocks that pay dividends. That is because you may have to pay a non-residents’ withholding tax of 15% on these dividends. You cannot claim a foreign tax credit for U.S. dividends on your Canadian tax return. In an RRSP, you won’t have to pay a withholding tax on your U.S. dividends.
So, if you want to buy a U.S. stock like Walmart (NYSE:WMT), which pays a dividend of US$2.12 per share annually, it’s preferable to buy it in an RRSP, so you can keep the entire dividend. If you don’t have any more room in your RRSP, you should buy the stock in a non-registered account, so you can benefit from a foreign tax credit.
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Fool contributor Stephanie Bedard-Chateauneuf owns shares of Walmart Inc.