The Tax-Free Savings Account, or TFSA, has gained popularity in Canada, since it was introduced in 2009. A tax-sheltered account, the TFSA is very flexible and allows you to generate wealth over time.
The TFSA can be used to hold several qualified investments such as bonds, guaranteed income certificates, stocks, exchange-traded funds, and mutual funds. Moreover, these instruments can be liquidated at any time, allowing you to withdraw funds without paying a single dollar in taxes.
So, the benefits of a TFSA can be leveraged to help Canadians achieve their financial goals, which might range from saving for a mortgage down payment to funding your child’s education.
But here are some big TFSA mistakes investors should avoid in 2023 that may result in lower returns or even fines from regulators.
TFSA mistake #1: Overcontributing to this account
The biggest mistake TFSA investors make is overcontributing to this account. Each year, the TFSA contribution limit is set, which is typically indexed to inflation. For 2023, the maximum TFSA contribution limit stands at $6,500.
So, if you would have invested $6,500 at the start of 2023 in high-growth stocks such as Tesla, you would have already returned 50% year to date. Let’s assume you withdraw these funds today and book a neat profit, while patiently waiting for the next pullback.
But if the stock market tanks again by the end of 2023, be sure to wait for the next year to make additional TFSA payments. Investors get a chance to replace TFSA withdrawal amounts but have to wait until the following year.
The Canada Revenue Agency levies a 1% tax each month on the excess TFSA amount. So, if you have overcontributed by $3,000, you will be charged a penalty of $30 each month by the Canada Revenue Agency.
TFSA mistake #2: Holding low-yield bonds
The tax benefits of a TFSA should be leveraged as much as possible, making it an ideal account to hold quality growth and dividend stocks, instead of low-yield bonds. While interest rates have risen considerably in the last year, equities have historically generated much larger returns over time.
The primary aim of investing is to beat inflation and lead a comfortable life in retirement, which might be difficult by investing in low-yield, fixed-income instruments.
TFSA mistake #3: Selling your winners too fast
Investors can potentially create game-changing wealth by purchasing shares of blue-chip TSX stocks such as Canadian National Railway (TSX:CNR). While the TSX stock is up 2.6% in the last 12 months, it has returned 87% in the last five years, 300% in the last 10 years, and almost 2,000% over two decades.
Canadian National Railway is among the largest companies in the country with a market cap of $110 billion. It is engaged in the rail transportation business, which is fairly recession-resistant, allowing CNR to keep generating cash flows across market cycles.
A consistent expansion in earnings has allowed Canadian National Railway to increase its quarterly dividends from $0.03 per share in 2001 to $0.79 per share in 2023, indicating annual growth rates of 16%, which is exceptional.
So, if you have successfully identified a long-term winner avoid liquidating your position in these stocks to benefit from the power of compounding.