Introduced more than 15 years ago, the Tax-Free Savings Account (TFSA) has gained popularity among Canadians. The TFSA is a registered account that allows you to hold certain qualified investments and benefit from tax-free returns for life.
The Canada Revenue Agency increases the TFSA contribution limit each year in line with inflation. In 2024, the limit was increased to $7,000, bringing the cumulative contribution room to $95,000.
In addition to its tax-sheltered status, the TFSA offers Canadians a ton of flexibility, as the funds can be accessed or withdrawn at any time. In this article, I have outlined three common TFSA mistakes you must avoid in 2025.
TFSA mistake #1: Holding cash
According to a Bank of Montreal report, around 47% of TFSA holders have their savings in cash, thereby missing out on opportunities for enhanced tax-free growth. It’s crucial to understand that you can hold multiple assets in the TFSA, which includes stocks, bonds, exchange-traded funds, and mutual funds.
Canadians with a short-term investment horizon can hold fixed-income instruments such as Guaranteed Investment Certificates (GICs) and earn passive income on their deposits. For instance, a $10,000 GIC deposit with a 4.5% yield will generate $450 in annual interest income.
Individuals with a longer investment horizon should consider holding low-cost ETFs and fundamentally strong stocks in a TFSA. Alternatively, owning a portfolio of quality dividend stocks will help you benefit from steady passive income and capital gains.
One such top TSX stock is Brookfield Infrastructure Partners (TSX:BIP.UN), which currently offers a tasty dividend yield of 4.8%. In the last 10 years, Brookfield Infrastructure has returned 160% to shareholders. However, if we account for dividend reinvestments, total returns are closer to 316%, easily outpacing broader market returns.
TFSA mistake #2: Not maximizing contributions
The primary goal for Canadians should be to maximize their TFSA investments. It’s also important to know that any unused balance can be carried forward to subsequent years. So, if you were unable to meet the TFSA contributions for the current year, it’s essential to take advantage of a larger contribution limit in the following years.
One way to maximize these contributions is to invest regularly in the account. Given annual returns of 10%, a monthly investment of $500 would surpass the $100,000 threshold over 10 years. Over 20 years, you might be able to increase this amount to $382,000, all of which will be tax-free.
The S&P 500 index has generated an average annual return of 10% in the past five decades. So, the best way for most TFSA investors to gain exposure to the equity market with enough diversification is by investing in a low-cost fund that tracks the index.
TFSA mistake #3: Choosing incorrectly between a TFSA and RRSP
According to financial experts, individuals earning below $50,000 annually should prioritize TFSA contributions over the RRSP (Registered Retirement Savings Plan). In this case, the individual is already in the lowest tax bracket, and further reducing the taxable income will not have an incremental impact on savings.
In an ideal scenario, you would want to maximize contributions to both accounts. However, for those in a lower tax bracket, it’s imperative to get these allocations right, which will, in turn, help them build wealth over time.
