TFSA Investors: 1 Fatal Mistake to Avoid During RRSP Season

To avoid getting hit with RRSP taxes, have your TFSA well funded with ETFs like iShares S&P/TSX Capped Composite Index Fund (TSX:XIC).

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Are you a TFSA investor who also has an RRSP?

If so, it’s worth being reminded of these accounts’ dos and don’ts. As I’ve written in the past, it’s easy to kill your returns by over-contributing, holding prohibited investments, or day trading in your registered accounts. These are all fairly well known and well publicized “no-nos.” However, there’s another big trap you can fall into that’s not as well publicized — an account action that might seem logical but could actually hit you with a massive tax bill. Every year, many Canadians attempt to do this, and find themselves getting in trouble as a result. If you do make this mistake, you could get taxed by as much as 50% of your holdings’ value.

So, what is this big mistake?

Transferring funds from your RRSP to your TFSA

Transferring funds from your RRSP to your TFSA might seem like a great idea. After all, we could all use a little extra TFSA cash, and RRSPs seem like a logical place to get it. However, this move has tax consequences that aren’t worth it. If you transfer funds from your RRSP to your TFSA, you’ll have to liquidate the shares and transfer the funds to a non-registered account first. The Canada Revenue Agency considers this an RRSP withdrawal, so you’ll pay tax on it — potentially as high as 50% if that’s your marginal tax rate.

Don’t do this unless absolutely necessary

It goes without saying that you shouldn’t transfer funds from an RRSP to a TFSA unless absolutely necessary. As previously mentioned, it’s a withdrawal under Canadian tax law, and the taxes can seriously eat into your returns. There is a form (T2033) that allows you to transfer funds directly from an RRSP to other registered accounts without tax consequences, but TFSAs aren’t covered by that form. So, if you’re a TFSA investor, it’s imperative that you fund your account without taking savings out of your RRSP.

What to do instead

Instead of transferring money to your TFSA from an RRSP, you can increase your TFSA cash balance by holding dividend-paying stocks in the account. By letting your dividends accumulate over time, you can see your TFSA cash balance grow — even if you have all your savings tied up in RRSPs. Then you can use the proceeds to buy more shares.

One great investment for this strategy is iShares S&P/TSX Capped Composite Index Fund. This is an ultra-diversified, low-fee ETF based on the TSX Index. The fund is about as low-risk as you can get with stocks, and it has one of the lowest MERs I’ve seen anywhere — a stunningly low 0.05%. That fee is low enough that you almost certainly won’t notice it and more than worth paying to buy the market.

What’s really worth mentioning about XIC in this context is its dividend yield. At 2.8% (trailing), it’s among the highest you’ll find in a true index ETF. There are dividend funds that have higher yields, but they’re often actively managed, which may result in huge fees. XIC has a high enough yield to produce significant income even in a TFSA, so you can gradually build cash to buy other investments. You can also just reinvest your XIC units automatically to grow your position. Overall, it’s a solid cash-building TFSA investment for any investor.

Should you invest $1,000 in Ishares Core S&p/tsx Capped Composite Index Etf right now?

Before you buy stock in Ishares Core S&p/tsx Capped Composite Index Etf, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Ishares Core S&p/tsx Capped Composite Index Etf wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $20,697.16!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 29 percentage points since 2013*.

See the Top Stocks * Returns as of 3/20/25

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 Andrew Button has no position in any of the stocks mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Dividend Stocks

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Dividend Stocks

I’d Put $15,000 in These 3 Dividend-Growth Champions for Increasing Income Potential

Want to offset some volatility? Here are three defensive dividend-growth champions that can generate a juicy yield right now.

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

Transform Your TFSA Into a Cash-Creating Machine With $7,000

Discover how the Tax-Free Savings Account can be your golden goose for generating cash without losing your investment.

Read more »

monthly desk calendar
Dividend Stocks

How I’d Invest $10,000 in Canadian Value Stocks for Monthly Dividend Income

A $10,000-diversified portfolio of value stocks focusing on dividend safety, yield, growth, and payment schedules can provide a reliable source…

Read more »

a person watches a downward arrow crash through the floor
Dividend Stocks

Is This Correction Your Chance? Top 4 Canadian Dividend Stocks on Sale

Stocks may be down, but now is your chance to get some of these top dividend stocks on sale.

Read more »

Confused person shrugging
Dividend Stocks

Where to Invest $2,500 in the TSX Today

These TSX stocks offer attractive dividends and a shot at decent upside on a rebound.

Read more »

Pile of Canadian dollar bills in various denominations
Dividend Stocks

Invest $25,000 in These Dividend Stocks for $1,956.66 in Annual Passive Income

Dividends stocks can make a huge difference, even if shares don't move an inch. And these might be the best.

Read more »

Pile of Canadian dollar bills in various denominations
Dividend Stocks

Got $5,000? 5 Income Stocks to Buy and Hold Forever

These income stocks have a solid dividend-payout history that can help you earn stress-free passive income.

Read more »

grow money, wealth build
Dividend Stocks

Why I’d Invest $10,000 in This Undervalued Dividend-Growth Stock for Decades of Income

This undervalued dividend stock offers a high yield of over 8% and can help you earn more than $200 in…

Read more »