The Tax-Free Savings Account (TFSA) has been a revelation for Canadians ever since the government introduced this account type in 2009. Designed to encourage Canadians to improve their savings practices, the TFSA is far more than a mere savings account.
The tax-advantaged account can allow you to achieve various short- and long-term financial goals if you use it as an investment vehicle. From saving up to make a down payment on your car to accumulating substantial wealth for a secondary retirement fund, the TFSA can do it all for you.
The account’s most attractive feature is its tax advantages. Any contributions you make to the account are in post-taxed dollars. It means that if your assets in the account generate any returns, the Canada Revenue Agency (CRA) cannot touch a cent as income taxes.
As amazing as it is, the TFSA does have its limitations. There may be certain situations that might see you end up compromising its tax-free status.
Contributing too much
Many TFSA users become very excited about the savings they can accrue through the account. However, there is a contribution limit to the account that the CRA keeps updating each year. As of 2021, the cumulative contribution room in the account is $75,500. It means that if you turned 18 in the year this account was introduced and have not contributed to the TFSA, you can contribute up to $75,500.
However, you should check with the CRA to find out what your remaining contribution limit is before you make a contribution to the account. Exceeding the contribution limit will allow the CRA to charge you 1% tax penalties for each excess dollar in your TFSA every month.
The TFSA allows you to trade stocks using the account. However, it was not designed specifically for that purpose. It is the Tax-Free Savings Account and not a trading account. Many investors can get the bright idea to use their TFSA’s tax-sheltered status to carry out day trading without having to pay the CRA taxes for the transactions. However, using it for heavy trading can land you in trouble.
If you begin using it as a day trading account, the CRA will take notice and begin taxing your earnings as business income. It is better to use the account for long-term investments that can provide you with reliable returns.
Dividend stocks can let you generate tax-free passive income that the CRA can’t tax. However, you should not use your TFSA to store U.S. dividend stocks. If you are interested in companies that pay U.S. dividends, a Registered Retirement Savings Plan (RRSP) might be a better alternative.
The CRA charges a 15% withholding tax on dividend income from US companies. Besides the hefty tax, you cannot claim the tax credit for US dividends when you file your tax returns.
Canadian dividend earner to consider
BMO is a staple investment in investor portfolios with a long-term horizon. The bank has been providing its shareholders with reliable dividend payouts each year for the last two centuries. Additionally, it has been increasing its dividends for more than five years, making it a Canadian Dividend Aristocrat.
BMO took a significant beating due to the pandemic. However, its wide economic moat allows the bank to continue funding its increasing dividend payouts. The stock can be an excellent income-generating asset you can add to your TFSA portfolio. Trading for $95.75 per share at writing, it is paying its shareholders at a juicy 4.43% dividend yield.
BMO is a picture of reliability in investor portfolios. The company has a strong dividend-paying streak that is older than most companies on the TSX and shows no sign of suspending its dividends despite the pandemic. It could be a good stock to consider as the foundation of a dividend income portfolio in your TFSA.
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Fool contributor Adam Othman has no position in any of the stocks mentioned.