4 TFSA Mistakes to Avoid

After the excitement of new contribution room in a new year, and before RRSP season steals the show, it’s a good time to quickly check if you’ve got your TFSA on track for the year.

But first, a reminder. A Tax-Free Savings Account, or TFSA, is a registered plan that allows you to save up to a certain amount of money each year without paying income tax.

The TFSA was introduced in 2009, and if you were 18 on that date (and have a valid SIN), you have a lifetime contribution limit of $81,500. The limit for 2022 is $6,000. Many people see the word “savings” in a TFSA and the first thing they think of is that it’s a place to save money for things like vacations or a rainy day fund. But that’s not a good idea. The TFSA is an ideal investment account, especially if you want to take advantage of the magic power of compound interest. In fact, there’s no other place where you can grow your money tax-free, and also remove it is tax free.

But aside from using the TFSA to store money, there are other small mistakes that could cost you dearly, mistakes Adam Bornn, financial planner at Parallel Wealth, sees all too often at his desk. Bornn, with a growing Canadian personal finance presence on YouTube, has created a popular article that spreads the word about these common pitfalls. We reached out to him to talk about it, and he pointed out the errors he thinks you should be aware of. Here they are, in no particular order:

Mistake #1 – Borrowing to invest in your TFSA

Compilation works both ways. The compound interest you pay to clear the debt can also cost you dearly. A big mistake Bornn encounters with TFSAs involves investors carrying high-interest debt, on their credit cards for example. You may not want to invest right now. “Let’s eliminate this debt first,” Bornn said. “There’s no point in paying 20% ​​on a credit card with a balance of ten thousand dollars and having a ten thousand dollar TFSA account earning, say, 5% a year.” That 15% gap, he notes, is costing you dearly. $1,500 on this scenario.

Which also answers another thing we often hear from our readers: “Should I borrow to invest? The idea behind this strategy is that you aim to invest your money so that it grows at a rate greater than the interest you pay on the loan you’ve taken out – which is easier said than done. Christine Benz, director of personal finance at Morningstar, warns that investors need to think carefully about whether they can realistically earn on different types of investments. “In this case, there is a lag between a secured obligation (borrowing cost) and the return, which is uncertain regardless of where you invest, unless you are in cash,” she says. “And with cash vehicles, you won’t come close to matching your borrowing costs.”

Mistake #2 – Contributing and withdrawing in the same year

Another scenario that could cost you dearly is the mistake of contributing, then withdrawing and contributing again in the same year. The TFSA is not quite designed for this. Every time you put money into your TFSA, even if you “repay” some of the money you previously borrowed, you still use up your contribution room. And that can be a problem.

Bornn gives an example: January 1^st2022, you deposit the full amount of available contribution room: $81,500. You keep some money and then decide to buy a new sports car, so you withdraw the money. But car prices are rising too much, and you decide to wait, before putting it back into the TFSA in the fall. Big mistake. ” You can not do that. You’ve already reached your maximum for that year,” Bornn says, “you can’t contribute until 2023.”

If you over-contribute, there’s a one percent per month penalty – not cheap!

Mistake #3 – Incorrectly registering your spouse

(Quebec residents: please skip to #4)

One thing to remember with a TFSA is that you can name a beneficiary, a successor, or both. There is a difference. A beneficiary would get all the money from your TFSA and get it tax free, and after that the account would be closed. A successor gets the account and the money.

One of the most common mistakes Bornn sees with clients and their TFSAs involves their spouses and how they are listed as beneficiaries. “If you have a spouse or common-law partner, be sure to indicate a successor holder. Not a beneficiary.

As an example, let’s take a hypothetical couple Jim and Sally. If Jim dies, what happens? “She [Sally] would get the money as a beneficiary, but she could only put that money into her TFSA if she had the right to contribute“Adds Bornn,” If Sally was listed as successor holder on Jim’s TFSA, then she could actually pool it into her TFSA even though she had no contribution room.

The distinction on your TFSA forms can make a difference of thousands of dollars, Bornn says, and it could cause your Old Age Security (OAS) to be clawed back.

Mistake #4 – No year-end tax plan

One big mistake Bornn encounters with his clients that he says isn’t talked about enough is TFSAs that don’t come with a schedule that matches your financial plan. “Let’s say you knew you needed $25,000 for something in February and you maxed out your TFSA. We often ask clients to make that $25,000 withdrawal in December, so by February we already have that money in the bank account ready to go. Later in the year, if the customer has money to spend, they can contribute up to that amount.

If you need money at the start of the next calendar year and you’ve maxed out your TFSA, the account can be used as a financial planning tool, Bornn says. It will give you the money you need while giving you the flexibility to add it back to the account and earn a higher return, tax-free. Not your everyday savings account!