Since its creation, the Tax-Free Savings Account (TFSA) has grown in popularity in Canada. The account type was introduced to encourage Canadian households to save more money. The TFSA allows you to earn on your investment completely tax-free.
As remarkable as the TFSA is, there are a few mistakes that Canadians make, which results in their assets being taxed. Here are the mistakes you need to avoid if you want to benefit from your TFSA fully.
Many Canadians make the mistake of contributing too much to their TFSAs. The TFSA has a maximum contribution limit, which the government increases by around $6,000 every year. As of this writing, the total TFSA contribution room is $63,500. The contribution room will increase by a further $6,000 next year.
Contributions that exceed this amount will be liable to tax penalties, according to the Canada Revenue Agency (CRA). For any amount that goes over the contribution limit, you will have to pay a penalty of 1% every month until you withdraw the excess amount from the TFSA.
It is essential to keep track of your contributions and to be careful not to exceed the limit.
Trading too much
The fact that your TFSA’s earnings cannot be taxed might give you a bright idea of using the account for trading stocks in the account. Technically, you can do that, but it does not mean you should. If you do start using your TFSA for day trading, there will be consequences.
A TFSA is suitable for long-term holding. The government will keep track of your activity related to the TFSA. If it notices that you are making several hundred trades every year, your revenue will be treated as enterprise revenue. You will be taxed accordingly by the CRA. Therefore, stick to stocks that you can hold for the long run.
Holding stocks with U.S.-based dividends
If you are an investor who owns shares from the U.S. that pays dividends, a TFSA is not the ideal place to store it. There is a chance that you will end up having to pay a non-residents’ withholding tax on the dividend income from U.S. stocks.
The non-residents’ withholding tax is charged at a rate of 15%. Besides the tax, you cannot claim a foreign tax credit for U.S. dividends on your Canadian tax returns. Instead of holding your U.S. stocks in a TFSA, you can use your Registered Retirement Savings Plan where it will not be taxed. Canadian stocks with a decent dividend income are a far better option to consider for your TFSA.
For instance, stocks from Canadian Natural Resources (TSX:CNQ)(NYSE:CNQ) can be an excellent stock to buy and hold in your TFSA. Also known as CNRL, Canada Natural Resources is the country’s leading independent natural gas producer. The company also has significant operations for natural gas liquids, offshore oil facilities, heavy oil, light oil, and oil sands.
The diversified sources of revenue enable CNRL to mitigate the volatility of market price fluctuations. The company can get the best returns on its investments due to its approach to business.
Shareholders of CNRL stocks are particularly happy due to its reliable dividend payouts. At the time of this writing, you can pick up the company’s shares for $38.87, with a dividend yield of 3.86%. In 2019 alone, CNRL raised its dividend by 12%, and it has healthy fundamentals for further growth. I think holding Canadian dividend-paying stocks like CNRL and keeping track of your contributions can help you make the most of your TFSA.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Adam Othman has no position in any of the stocks mentioned.