Are you unknowingly sabotaging your TFSA? Making the wrong moves with your TFSA today can cost you thousands of dollars down the road. The good news? Most of these mistakes are easy to fix, often in just 10 minutes. Here are 8 big TFSA mistakes you need to avoid.
Naming a Beneficiary Instead of a Successor
This is the easiest mistake to correct in this entire list, but also one of the most impactful. If you’re married or in a common-law relationship, you need to name your spouse as a successor holder for your TFSA—not just a beneficiary. Here’s an example to show why:
Example:
Let’s say Jack has a TFSA with $100,000 in it, and he names his spouse, Jill, as a beneficiary. When Jack passes away, Jill inherits the $100,000, but the TFSA is closed. Now, Jill has to transfer the funds to a non-registered account, and any future gains on that $100,000 are subject to tax. Also, the TFSA contribution room is lost forever, so future growth isn’t tax-sheltered. If Jill earns a 5% return on that money annually, she could owe taxes on $5,000 of gains each year.
But if Jack names Jill as a successor holder instead, she takes over the TFSA completely. The $100,000 stays in the TFSA, and any future gains remain tax-free. Jill’s own TFSA contribution room is unaffected, meaning she can continue contributing to her own account while benefiting from the tax-free growth of Jack’s TFSA as if it were her own. For example, if Jill earns that same 5% return on the $100,000, she won’t owe a cent in taxes on the $5,000 annual gains, keeping her money working harder.
How to Fix It:
Contact your bank or TFSA provider and ask to update your account, naming your partner as the successor holder. This 10-minute task could save your loved ones from losing out on significant tax-free growth.
Not Coordinating Your TFSA with Your Overall Financial Picture
Not coordinating your TFSA with other accounts like your RRSP and CPP can lead to missed opportunities and less efficient tax strategies. While the TFSA is flexible and powerful, treating it in isolation could cost you in the long run.
For example, if you’re in a high 35% tax bracket, contributing $10,000 to your RRSP instead of your TFSA could save you $3,500 in taxes right now. That RRSP tax savings can be reinvested, growing your wealth, or even reinvested in your TFSA. In retirement, when you’re in a lower tax bracket, say 20%, withdrawing from your RRSP would cost much less in taxes.
Similarly, delaying your CPP from age 60 to 70 can boost your monthly benefit from around $640 to $1,420. Using TFSA withdrawals during that period can cover the income gap without increasing your taxable income, keeping you in a lower tax bracket and avoiding the OAS clawback.
I’ve worked with so many clients who were focused on maxing out their TFSA, but overlooked their RRSP. Once we crunched the numbers, we found they could have saved thousands more in taxes by balancing contributions between both accounts.
At Blueprint, we run different scenarios to help clients optimize their financial plans and answer key questions like “Should I prioritize my TFSA or RRSP?” and “What’s the best withdrawal strategy to maximize my estate?” It’s all about finding the right mix that works for your long-term goals.
Swinging too hard for the fences
I see this a lot, especially with younger clients eager to hit it big. They want to go all-in on high-risk investments like meme stocks, cryptocurrencies, or penny stocks, hoping to double their money overnight in their TFSA. But here’s why this approach often backfires.
These types of investments are incredibly volatile. Even if you manage to double your money in a year, would you really cash out and move it into something safer? Probably not—you’d likely let it ride, exposing yourself to even bigger risks. The more you gamble, the greater your chances of losing big.
Charlie Munger, Warren Buffett’s longtime business partner, wisely said, “The big money is not in the buying and selling, but in the waiting.” If you’re investing for the thrill of it, that’s one thing. But if your goal is to secure your financial future, you need a strategy that balances risk with reward.
Let’s say you contribute $10,000 to your TFSA and put it into a high-risk investment. If it drops by 50%, you’re left with just $5,000. The worst part? In a TFSA, you can’t claim that loss on your taxes, and you don’t get back the contribution room. That lost space is gone for good, reducing your future tax-free growth potential. Instead of building wealth, you’ve dug yourself into a hole that’s tough to climb out of.
The key here is balance. It’s fine to take some risks, but don’t swing for the fences with everything. Slow, steady, and consistent growth may not sound thrilling, but it’s the smartest way to build real wealth over time.
Investing in a TFSA Before Paying Off High-Interest Debt
I’ve seen this mistake a lot while working as an advisor. It might seem like a smart move to start investing in your TFSA right away, but if you’re carrying high-interest debt, like credit card balances, it’s better to deal with that first.
Think about it—credit card interest rates can hit 20% or more. It’s incredibly tough for any investment to consistently earn returns that high. Those types of returns are reserved for elite investors, for example, Warren Buffett through his company Berkshire Hathaway has delivered an average annual return of around 20% since 1965.
By focusing on paying off high-interest debt, you’re effectively earning a 20% return on your money. Not only does this save you a ton on interest payments, but it also puts you in a much stronger financial position. Once that debt is cleared, you’ll have more freedom to invest without the burden of high-interest payments hanging over you.
Take a step back, assess your debt situation, and consider redirecting funds toward paying it off. Once you’re debt-free, you’ll be able to invest more effectively and watch your TFSA grow without worrying about interest draining your hard-earned money.
Using Your TFSA as Just a Savings Account
You might think that keeping your money in a TFSA savings account is a smart move. While it’s safe, this approach can actually hinder your wealth growth. Inflation gradually erodes the purchasing power of your money, meaning your savings might not keep up with rising costs over time.
Instead, consider investing in equities like stocks or bonds within your TFSA. These investment options have the potential for higher returns, helping your money grow more effectively. For example, if you invest $10,000 at a 2% interest rate, after 20 years you’d have about $14,859. But if you invest the same amount with an average return of 5%, you’d end up with approximately $26,532. That’s a substantial difference that can significantly impact your financial goals.
Ignoring Foreign Dividend Taxes in Your TFSA
Investing in foreign assets like U.S or International stocks through your TFSA might seem like a smart move, but many people overlook the impact of withholding taxes on dividends.
Some countries, like the U.S., impose a 15% tax on dividends paid to foreign investors. While your TFSA is tax-free in Canada, it’s not recognized as such internationally, meaning you can’t recover that 15% tax.
For example, if you earn $1,000 in dividends from U.S. stocks held in your TFSA, $150 will be withheld, and there’s no way to get it back. Over time, this can eat into your returns.
It’s important to note that this withholding tax applies only to dividends, not capital gains, so it’s not as bad as it might sound. Investing in U.S. stocks can still be beneficial, but if you have room in your RRSP, it may be a better place for these investments. Due to tax treaties, RRSPs often allow you to avoid or reclaim withholding taxes on foreign dividends.
Overcontribution mistakes:
Overcontributing to your TFSA can quickly lead to hefty penalties. Any amount over your TFSA limit gets hit with a 1% monthly penalty on the excess, and fixing it often means withdrawing the overcontribution and possibly negotiating with the CRA.
To avoid this hassle, it’s crucial to keep track of your contributions and withdrawals on your own instead of relying solely on the CRA’s website.
Common Overcontribution Mistakes:
1. Trusting the CRA’s Contribution Limits:
The CRA’s website may not always reflect recent transactions, which can lead to accidental overcontributions. It’s better to keep your own records—whether it’s a spreadsheet or a quick note on your phone—so you know exactly how much room you have left.
2. Re-Contributing in the Same Year:
If you withdraw money from your TFSA and re-contribute it in the same year, it doesn’t reset your contribution room. The room from a withdrawal isn’t restored until the next calendar year. If you contribute too soon, you could face penalties, so it’s best to wait until the following year to re-contribute.
3. Not Transferring Investments In-Kind:
When moving investments between accounts, selling them first can lead to overcontribution issues if you redeposit the money into your TFSA. To avoid this, you can transfer the investments “in-kind” (without selling), but even then, you need to be cautious about timing to avoid unintentionally reducing your contribution room.
Not Understanding the Technical Side of the TFSA
A lot of people miss out on the full potential of their TFSA by not fully understanding how it works. Here are a few key points to keep in mind:
1. Knowing What You Can Invest In
Not all investments are allowed in a TFSA. Some private or foreign assets might be prohibited, and investing in them could lead to penalties. Here is the CRA’s list of permitted investments. A little research can save you from costly mistakes.
2. Gains and Losses Don’t Impact Your Contribution Room
There’s a common myth that investment gains or losses within your TFSA affect your contribution room. The truth is, they don’t! Your room is only based on deposits and withdrawals, not how your investments perform. Whether your investments skyrocket or dip, your TFSA limits remain unchanged. This means you can focus on growth without worrying about affecting your contribution space.
3. You’re Not Limited to Your Bank
Many people think they have to stick with their bank’s investment options for their TFSA, but that’s not the case. You can explore platforms like Questrade, Wealthsimple, or EQ Bank, which often offer more options and lower fees. Taking the time to shop around can improve your returns and broaden your investment choices.
FAQ
1. What is the biggest mistake people make with their TFSA?
One of the most common mistakes is over-contributing to your TFSA. The Canada Revenue Agency (CRA) sets annual contribution limits, and exceeding these limits can lead to hefty penalties.
2. Can I hold only cash in my TFSA?
No, while many people assume a TFSA is just a savings account, you can hold a wide range of investments, including stocks, bonds, ETFs, mutual funds, and more. Limiting your TFSA to cash may prevent you from maximizing your tax-free growth potential.
3. What happens if I withdraw money and re-contribute it in the same year?
If you re-contribute money in the same year that you withdraw it, you risk over-contributing unless you have remaining contribution room. Withdrawals don’t add to your contribution room until the next calendar year.
4. Are foreign investments a good idea for my TFSA?
Foreign investments, especially those paying dividends, can be tricky. Many investors don’t realize that foreign dividends in a TFSA are often subject to withholding taxes that you can’t recover, which can reduce your returns.
5. Can I use my TFSA for short-term savings goals?
Yes, but it’s important to avoid trading too frequently. The CRA could classify you as carrying on a business, and your gains might become taxable. The TFSA is best used for long-term investments.
6. Can I contribute to my spouse’s TFSA?
You cannot contribute directly to your spouse’s TFSA, but you can gift money to them to contribute to their own TFSA without attribution rules applying, making it a useful tool for income splitting.
7. Does opening multiple TFSAs at different institutions increase my contribution room?
No, your total TFSA contribution room remains the same, regardless of how many accounts you open. The CRA tracks your contributions across all institutions, and exceeding your annual limit can result in penalties.
8. Can I designate anyone as a beneficiary for my TFSA?
Yes, but it’s a mistake not to designate a successor holder (usually a spouse) or a beneficiary. Without proper estate planning, your TFSA may lose its tax-free status upon death and become subject to taxes.
