Canada’s notoriously stringent tax regime does provide some benefits to savers and investors. Tax-free savings accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) offer the average saver some shelter to accumulate wealth over time and protect it from the taxman.
However, there are limits to the agency’s leniency and breaking the rules or misunderstanding the framework could have serious long-term consequences. With that in mind, here are three major mistakes investors should avoid in their registered accounts.
Frequent trading
TFSAs and RRSPs are designed to help long-term savers minimize their tax burden over time. In fact, the RRSP is designed to limit withdrawals and accumulate capital until the taxpayer reaches the age of retirement.
What these accounts are not designed for is rapid wealth creation through sophisticated and aggressive stock trading. Day traders can use their tax-free allowance to bet against stocks, make leveraged bets on risky companies and trade stocks on a daily basis to quickly turn a few thousand dollars into millions.
Savvy traders who’ve tried this have successfully pushed their TFSA beyond $1 million. However, they’ve also caught the attention of the Canadian Revenue Agency and been forced to pay fines for using the accounts in unintended ways. So, day traders beware.
Losing track of contributions
Another common mistake most investors make is to lose track of their contributions and withdrawals to registered accounts.
The TFSA was introduced in 2009, while the RRSP has been around since the 1950’\s. It’s not hard to imagine how investors can lose track of thousands of dollars placed in and pulled out of these accounts over multiple decades.
However, the Canadian Revenue Agency sets strict limits for contributions each year. The TFSA contribution limit for 2020, for example, is $6,000, the same as the year before. Going over this limit attracts a harsh penalty.
Meanwhile, under-contributing to these accounts is just as bad. Investors who are unaware of the limits or their personal contribution to registered accounts could be leaving thousands of dollars on the table.
In short, using an app or the services of a financial advisor to closely track these contributions is always a good idea.
Speculating with tax-free accounts
It’s hard to resist the temptation to speculate on exciting tech stocks or emerging pot companies. However, the downsides of reckless speculation are magnified when these bets are placed through registered accounts.
Permanently losing money in a TFSA account can reduce the contribution room savers have over time. For example, losing $1,000 on a company that went bankrupt in a TFSA account with $6,000 in contribution can reduce the contribution room to $5,000 if the investor decides to withdraw cash and reinvest a year later.
This little-known quirk of the TFSA makes speculation on risky stocks through registered accounts a bad idea.
Foolish takeaway
Canada Revenue Agency’s registered accounts come with speed limits. Crossing these boundaries, either intentionally or accidentally, could be detrimental.
It’s best to monitor your contributions every year and use the accounts to place long-term bets on safe and reliable stocks for the long term.
