Canada Revenue Agency: How to Avoid This Wealth-Destroying TFSA Pitfall!

It’s so simple to avoid this costly TFSA mistake, yet many Canadians could be at risk of stiff overcontribution penalties.

The investment gains and dividends within your Tax-Free Savings Account (TFSA) are free from taxation, making the vehicle an incredibly powerful way to accumulate wealth over prolonged periods of time.

The wealth-creative powers to be had with regular TFSA contributions and tax-free compounding (or dividend reinvestment) could allow one to snowball their wealth to unfathomable heights over the course of decades.

And while the TFSA is a seemingly simple and invaluable tool for all Canadians, it’s also important to follow the rules that come with its use to avoid getting caught offside with the Canada Revenue Agency (CRA).

There’s a strict rule set that TFSA users must follow

If one breaks the rules, they put themselves at risk of overcontributing.

As you may know, Canadians are granted a set amount that they’re allowed to contribute to a TFSA. For those who’ve yet to contribute and were of age since the TFSA’s inception in 2009, the cumulative amount will be $69,500 in 2020.

If you’re like many Canadians who’ve lost track of their contributions, you could be at risk of overcontribution, and the longer you remain above your TFSA limit, the stiffer your penalties could become. And don’t think for a second that the taxman won’t eventually find out if you’ve been deliberately overcontributing or have been aggressively guesstimating your contribution room.

The CRA charges 1% per month on any “TFSA excess amounts.” While the 1% may not seem like much, it could be a very harsh penalty if you’ve overcontributed by a considerable amount and have left it like that for an extended period of time.

Not to scare you, but the consequences of overcontributing have the potential to be quite severe. Fortunately, there’s no need to panic if you think you may be at risk of overcontributing if you don’t know the TFSA withdrawal rules by heart.

If you’ve lost track of how much room you’ve got left or if you’re at risk of overcontributing, you can simply check with the CRA to see precisely how much room you’re under or over the limit. And if you’re over, just make the necessary withdrawals and limit your potential penalties.

It’s better to be safe than sorry!

If you’re like many Canadians who use their TFSAs as a passive-income stream with popular high yielders like H&R REIT, it can be easy to lose track of your withdrawals and contributions over the years. And if you accidentally re-contributed the amount of your withdrawal within the same year, you could have impacted your contribution room for the current year.

So, if you find that cash moves in and out of your TFSA frequently, it can save you a fortune in penalties to double-check with the CRA, either by phone or through the online portal, to ensure you’re not going over the limit and to get a precise amount that you’re able to contribute at any given time.

The last thing you want is for stiff penalties to nullify the wealth-creative effects made possible by tax-free compounding within a TFSA. Given how ridiculously simple it is to check your contribution room, there really are no excuses for ball-parking a contribution amount unless you haven’t been contributing regularly in the past and know for certain that you’ve got ample room available.

Don’t risk the TFSA overcontribution penalties; it’s just not worth it.

Stay hungry. Stay Foolish.

Fool contributor Joey Frenette has no position in any of the stocks mentioned.

More on Investing

space ship model takes off
Stocks for Beginners

The Absolute Best Canadian Stocks to Buy and Hold Forever in a TFSA

These two proven Canadian companies are still growing, even as their stocks haven’t seen much appreciation of late.

Read more »

woman considering the future
Stocks for Beginners

Here’s What Retirement Savings Often Look Like for Canadians at 55

At 55, national “average” balances matter less than how much income your assets can reliably produce.

Read more »

workers walk through an office building
Stocks for Beginners

3 Undervalued Stocks to Buy Before the Crowd Catches On

These three TSX stocks are posting encouraging results while building businesses that could attract greater investor attention over time.

Read more »

dividend stocks are a good way to earn passive income
Dividend Stocks

I’d Buy This TFSA Stock to Deliver $42 in Monthly Income

This monthly dividend stock could help your TFSA generate reliable income today while offering long-term upside as its valuation gap…

Read more »

A woman stands on an apartment balcony in a city
Dividend Stocks

Here’s What the Typical Canadian’s TFSA Balance Looks Like at 60

A $45,000 TFSA at age 60 isn’t “done," many Canadians still have plenty of room to build it before 65.

Read more »

Investor wonders if it's safe to buy stocks now
Dividend Stocks

How I’d Use a $24,000 TFSA to Collect $58 Every Month

These two Canadian dividend stocks could help you earn regular cash while building long-term TFSA wealth.

Read more »

Retirees sip their morning coffee outside.
Dividend Stocks

A Canadian Dividend Stock Down 34% I’d Buy for Retirement Income

Nutrien’s 35% drop from its 2022 high could offer upside plus income, but only if fertilizer fundamentals keep improving.

Read more »

Piggy bank and Canadian coins
Retirement

Freedom 55: How Do Your TFSA and RRSP Savings Stack Up?

Freedom 55 can work, but you’ll need a “bridge” portfolio to cover years before CPP and OAS start.

Read more »