TFSA Investors: 3 Costly Mistakes to Avoid

While you can make lots of money in a TFSA without having to pay taxes, there are certain situations where the CRA will impose penalties.

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The TFSA is a fantastic enrichment tool if you know how to use it. If you put your TFSA in GICs, which offer meagre returns, you’re not using it at its full potential. Because returns accumulated in a TFSA are tax sheltered, you should aim to gain high returns in it.

Have your Shopify or Tesla shares tripled in value since you bought them? If your brokerage account is inside a TFSA, you don’t have to share your profits with governments.

You can take out money from your TFSA whenever you want to pay for whatever you want, such as a down payment on a home, without paying taxes. The operation creates additional contribution room that you can use in the future, starting the following year. You can then buy Shopify or Tesla shares again, accumulate money, and withdraw again.

The TFSA is so much more flexible and less complicated than the RRSP. But be careful. While you can make lots of money in a TFSA without having to pay taxes, there are certain situations where the CRA will impose penalties.

When you overcontribute

There is a limit to the amount you can put in a TFSA. Initially, in 2009, an investor could put $5,000 into it. The limit was gradually increased to $6,000, with the exception of 2015 when it reached $10,000, before being lowered the following year to $5,500. The limit has been increased to $6,000 in 2019.

You can open a TFSA when you’re 18 years old. From then on, the rights accumulate, so much so that a person who can contribute from the beginning without having benefited from it is now left with a TFSA shell capable of accommodating $75,500.

The problem with a TFSA is that it is easy to lose track, especially if you have more than one TFSA and frequently withdraw and deposit money.

Whether you have one or more TFSAs, you are subject to the same limits. When you withdraw from an account, you can’t deposit money in this account again until the following year. Otherwise, the deposit is considered a new contribution, and if you have already reached the limit, you are liable to a tax of 1% per month on the surplus. You have to withdraw the excess contributions to stop the accumulation of penalties.

Non-residents who contribute to a TFSA

A Canadian who works abroad cannot contribute to the TFSA.

Contributions made in spite of this would be subject to a tax of 1% per month. And if, by misfortune, the deposits are also considered excess contributions, the penalty discussed above is added to the bill.

The CRA is notified of the transactions made within a TFSA once a year. It takes several months for the CRA to detect any snags in their rules, so penalties can grow for a while before an offender is notified.

Day traders

The CRA prohibits day traders from using the TFSA to make tax-sheltered money. What the CRA looks at is not the returns, but the frequency of transactions, the length of time stocks are held, the use of leveraged loans, and the time spent managing the portfolio.

If the CRA determines that a TFSA is used to do day trading, it will treat returns as business income. Therefore, they will be fully taxable. So, you should be careful to not trade a lot in a TFSA.

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 Stephanie Bedard-Chateauneuf has no position in any of the stocks mentioned. David Gardner owns shares of Tesla. Tom Gardner owns shares of Shopify and Tesla. The Motley Fool owns shares of and recommends Shopify and Tesla.

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