A Tax-Free Savings Account (TFSA) is a great tool to help Canadians save money and invest it tax-free. However, to fully benefit from a TFSA, it’s important to avoid making certain mistakes. Here are five mistakes to avoid with a TFSA:
One of the most common mistakes people make with a TFSA is overcontributing. The annual contribution limit is set by the Canadian government and can change from year to year. It’s important to keep track of your contribution room and not exceed the limit. The total contribution room available to you depends on age and length of your tax residency in Canada. You can always check your available room at CRA website. If you overcontribute to your TFSA, you will be charged a penalty tax of 1% per month on the excess amount until it is removed from the account. To avoid this mistake, keep track of your contribution room and plan your contributions accordingly.
Withdrawing and recontributing in the same year
Another mistake to avoid is withdrawing money from your TFSA and then recontributing the same amount in the same year. If you have already maxed up your contribution room, this is considered an overcontribution and will result in penalty taxes. It’s important to wait until the next year to recontribute the amount you withdrew to avoid this mistake (unless you already have some unused contribution room from previous years).
Investing in prohibited investments
While TFSAs offer a lot of flexibility when it comes to investment choices, there are some investments that are prohibited. For example, investments in businesses that you control, investments in non-qualified investments, and investments in foreign property that are not traded on a recognized stock exchange are not allowed in a TFSA. It’s important to check the CRA guidelines to ensure that your investment choices are eligible for a TFSA.
Using your TFSA as a short-term savings account
A TFSA is a medium to long-term investment account vehicle, and it’s not intended to be used as a short-term savings account. While you can withdraw money from your TFSA at any time without penalty, it’s important to remember that any withdrawals will reduce your contribution room -at least temporary-. You will be given back the contribution room equal to amounts you withdraw but that happens in beginning of January each year. So, you may lose best timing for your investment. To maximize the benefits of your TFSA, it’s best to leave your money in the account and let it grow tax-free over time.
Not diversifying your investments
Finally, another mistake to avoid is not diversifying your investments within your TFSA. Diversification is key to reducing risk and maximizing returns over the long term. It’s important to spread your investments across different asset classes, such as stocks, bonds, and cash, and to rebalance your portfolio periodically to maintain the desired asset allocation. Always remember, as opposed to a non-registered account, losses in a TFSA account are NOT claimable as capital loss in your yearly tax filing. Investing in very high-risk investments will not only cause you lose your money, but it can also wipe put your accumulated TFSA contribution room too.
In conclusion, a TFSA is a powerful tool for saving and investing tax-free, but it’s important to avoid these common mistakes to make the most of your account. By staying within your contribution limits, avoiding overcontributions, investing in eligible investments, using your TFSA as a long-term investment account, and diversifying your investments, you can build a solid financial foundation for your future