One of the basic rules of good financial health is to have a decent portion of your income allocated towards saving. But one thing that people have trouble with is figuring out what to do with those savings. Most people think that the best way to use the money you set aside is to let it earn interest and compound in one of the registered savings accounts, like a TFSA.
But the problem with interest-based compounding is that it’s very limited. But investing can let you grow your wealth substantially. That depends heavily on your risk tolerance and how you are picking the stocks or funds to invest in. And when you are using your TFSA for investment, avoid two of the most common pitfalls many Canadians get trapped in: overcontribution and overtrading.
Doing any one of the two things can get you slapped with a tax bill. And getting taxed on your money in TFSA practically kills its primary purpose.
Mistake number one
Many people over tend to overcontribute because they don’t adhere to a “TFSA-funding” schedule and are haphazard savers. For example, you may be in the habit of contributing to your TFSA with whatever you have left at the end of the month. For a particular year, you may contribute $100 in January, nothing in February, and $800 in March. The chances are that you will lose track of your contributions, and mistakenly over contribute.
You may also overcontribute because you think that a particular investment is too good to pass by and invest a hefty amount in that stock in your TFSA. Either way, you will face a CRA tax bill for overcontribution. It’s better to keep your TFSA contributions in check. The ideal scenario is to set up an automatic contribution schedule, like putting $500 every month in your TFSA. It won’t exceed the $6,000 contribution limit for the year.
Mistake number two
What constitutes overtrading in your TFSA? Well, the TFSA was created for everyday Canadians to invest and grow their money and capitalize on tax-free growth. But if you “day-trade” (or overtrade) using your TFSA, the CRA might consider it as conducting business and tax some or all of your TFSA holdings as business income.
Overtrading or day trading is evaluated mostly on the frequency of buying/selling shares and your holding period for the securities.
Instead of making trades in your TFSA to realize higher capital gains, it might be a better idea to invest in a good growth stock. Park Lawn (TSX:PLC) is the largest Canadian-owned and publically traded funeral and cremation service in the United States. The company owns and operates cremation facilities and cemeteries and is one of the fastest-growing service providers of its kind in North America.
The company is consistently growing since its inception. It’s three, five, and 10-year CAGR averages out to 19.8%. It’s a morbid observation, but the business this company is in will likely always have a consistent or even high demand. So, there is a good chance that the company will keep growing at a steady pace, and your capital gains will grow with it. It also pays a dividend, and the monthly payout of 0.038 per share has stayed fixed since 2016.
If used correctly, a TFSA can help you become a millionaire, even with a relatively low contribution limit if you compare it to an RRSP. But whatever you make in your TFSA will be tax-free, and it can be an amazing help in adjusting your tax bracket in your retirement years. For that, you must remain in the good books of CRA and avoid TFSA-related mistakes.
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Fool contributor Adam Othman has no position in any of the stocks mentioned.