Incentives to save are welcome from the government. They are always trying to introduce new programs to try and address some of the challenges Canadians experience. From saving for a house, saving for retirement, and saving in general. The problem is they make them so convoluted for most Canadians, that a lot of people avoid them or make mistakes with them. When it comes to the Registered Retirement Savings Plan (RRSP) and Tax Free Savings Account (TFSA), the rules are not well understood by many. Then when they do make mistakes, such are re-contributing too soon to a TFSA or over-contributing to a RRSP, then penalties and interest costs can occur.
TFSAs took the Canadian personal finance world by storm when they were first introduced in 2009. Money invested in the account is allowed to grow tax free, making it a popular choice for many Canadians. The latest data available from Stats Canada showed more than 15.3M Canadians had a TFSA as of the 2019 tax year. The of course, covid hit the next year.
However, this tax-sheltered account is only as useful as one makes it to be. Here are the biggest mistakes Canadians are making with their TFSA.
Not investing money
The word ‘savings’ in the account name might skew some individuals’ perception about what the account should be used for.
The TFSA account has been, at times, advertised as a savings account which in turn led many individuals to use it as an actual bank savings account, keeping cash and GICs within it rather than investing it. I think it would be better labeled as an investment account rather than a savings account.
TFSAs can hold a variety of investments such as stocks, bonds, mutual funds, exchange traded funds, and segregated funds that can generate much greater tax savings than holding cold hard cash in the account. Funds within the TFSA should be invested in a diversified portfolio according to an individual’s risk tolerance, while keeping a long-term investment horizon in mind.
Saving for short term goals
Opportunity cost, or the risk of losing out on potential gains when choosing one investment over another, is a big issue for Canadians that treat their TFSA as a short-term savings account. To take full advantage of a TFSA, people should be encouraged to maximizing their contributions each year and investing for the long term.
If you use your TFSA like a regular savings account and hold only cash or cash equivalents, you may miss out on long-term investment opportunities.
High Interest Savings Accounts, which offer a higher interest rate than typical savings accounts, or GICs, that offer a return on cash with very low risk, are much better alternatives for short-term savings goals depending on the individual’s unique financial situation.
Losing track of contribution room
The 2023 contribution limit increased by $6,500, bringing the total contribution limit to $88,000 if you’ve never contributed to a TFSA before.
The good news is contribution room accumulates each year, but investors need to be extra careful about their contribution limits, especially if they’ve withdrawn money in the current year or have multiple TFSAs.
The reality is that many people have added money, taken it out, and opened accounts at different institutions over the years so calculating your TFSA room now becomes akin to solving a quadratic equation. This is challenging to most and can result in people avoiding investing in TFSAs or over-contributing because they do not understand the CRA imposed rules.
For example, investors who max out their contributions in a given year and then withdraw money will have to wait until the next year to have that contribution room added back. Let’s say you withdrew $8,000 last year. When January 2023 comes around, you not only have the additional annual room of $6,500 that all Canadian residents 18 and older receive, but you also get the $8,000 contribution room added to your total room from the withdrawal as well.
Exceeding your available contribution limit in a given year could result in a one per cent penalty per month on the excessive amount until it’s withdrawn. In some cases, the Canada Revenue Agency can forgive the penalty if the excess contribution is withdrawn quickly.
If you’ve been keeping an up-to-date spreadsheet of each deposit and withdrawal from your TFSA) over the years, then kudos to you! But for the majority of people who didn’t realize it could get this complicated, don’t worry, all hope is not lost.
The best place to confirm contribution room is MyAccount on the CRA website but be cautious as money that flows in and out of the account in the previous year might not be reflected until the end of February.
These types of errors are more common than we may realize. That is why working with a Financial Planner may be advised. They can track your entitlements and limits and incorporate them into your investment strategy and plan.
To feel confident about managing your TFSA room, we suggest using a combination of tracking your deposits and withdrawals and confirming with the number reported by the CRA. To keep it simple, consider sticking to having just one TFSA account rather than multiple accounts across different firms. Simplicity is the key criteria in Keeping Life Current.