According to the Canada Revenue Agency (CRA), four out of five Canadians are making a critical mistake with their Tax-Free Savings Accounts (TFSAs) that is keeping them from maximizing the potential benefits of the account.
I am going to discuss the mistake that, surprisingly, so many Canadians are making with their TFSAs, so you can take measures to correct it and reap the most benefits from the account.
Not maxing out contributions
According to the CRA, despite the flexibility and benefits offered to TFSA holders, 80% of Canadians with the account are not maxing out their contribution room. The 80% remains consistent across Canadians across various parts of the income curve. The average numbers indicate that 20% of Canadians earning between $20,000 to $25,000 per year are meeting contribution limits. The number stays the same for those earning over $80,000 per year.
For Canadians earning more disposable income, you might assume that they will be regularly contributing to their TFSA. However, there is a remarkable number of people who still have not met the limit. With the 2020 update, the maximum contribution room since inception for TFSAs is $69,500 after the $6,000 additional space added this year.
TFSAs are an ideal avenue to store and grow funds. The account allows your investments to grow through capital gains and dividends without incurring any income tax. You can also withdraw funds from the account without worrying about paying fees or penalties. Further flexibility with deposits and withdrawals includes the ability to re-deposit the amount you withdrew the previous year from your account in the next year.
For instance, if you withdrew $10,000 from your maxed-out TFSA in 2019, you can add the $10,000 plus the $6,000 this year in your TFSA.
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Invest in dividend stocks
The tax benefits investors stand to gain from TFSAs is arguably one of the most significant reasons why it is a fantastic tool you should consider using. The account lets you withdraw without incurring taxes, penalties, or fees. You should use the contribution to allocate funds towards assets that can grow in your account to boost the overall amount.
Using the account to store growth stocks like Shopify or Lightspeed POS is a fantastic way to capitalize on capital gains. However, you can also use dividend-paying stocks to add cash to your account tax-free. Consider a risk-averse asset like Fortis (TSX:FTS)(NYSE:FTS) for an asset that can continue to grow your wealth without risking your capital amid market volatility. You can rely on it for its capital gains and earn passive income.
Fortis is a Canada-based electric gas and utility company. The utility sector is a haven for investors during times of economic crisis. Where most other companies begin to falter at the first sign of trouble in the stock market, utility companies like Fortis can remain solid due to the essential nature of service that utility companies provide.
The company relies on regulated and long-term contracts for most of its revenue. It means that even if the economic situation worsens, Fortis will have the cash flow to keep financing its dividend payouts to its shareholders. At writing, the stock is trading for $54.22 per share, and it pays its shareholders a decent 3.52% dividend yield.
Maxing out the contribution room in your TFSA and allocating a significant portion to reliable dividend stocks can help you make the most of it. While you should consider adding growth stocks to the portfolio to leverage capital gains, adding stock like Fortis can help you earn consistent income through dividends in your TFSA that you can reinvest or withdraw without worrying about taxes.
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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 owns shares of Shopify. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Shopify and Shopify. The Motley Fool owns shares of Lightspeed POS Inc. The Motley Fool recommends FORTIS INC.