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The 7 deadly TFSA sins

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  By Guest Blogger Sinan Terzioglu
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Earlier this week Garth laid out the facts on how Canadians are using their 18-million TFSA accounts. We have clearly opened them in volume. But this powerful tax-sheltered tool remains widely misunderstood and underused. Many people either don’t contribute regularly or fail to use the account effectively, missing out on valuable years of tax-free growth. Some even make costly errors, which can result in significant penalties.

To make the most of your TFSA, it’s important to avoid common mistakes. Below are some of the most frequent pitfalls and how to steer clear of them:

Overcontributing.

Many Canadians unintentionally exceed their TFSA contribution limits, often due to confusion around how contribution room is tracked. The CRA’s My Account portal does not update recent contributions immediately, especially those made within the current calendar year. Relying solely on this information can lead to the mistaken belief that more room is available than there actually is.

Overcontributions are subject to a one percent monthly penalty tax, which can become costly over time. To avoid this, it is important to keep your own records and consider maintaining a single TFSA. Also, remember that withdrawn amounts can only be recontributed in the following calendar year unless you have unused room carried forward.

Using a TFSA primarily for low-yield savings.

According to the CRA, nearly 40% of TFSA holdings are in cash and GICs, with many Canadians treating the account as a simple savings account rather than a long-term investment tool. This approach significantly limits the TFSAs long-term potential. For instance, a couple contributing $14,000 annually and earning a 6% average return could accumulate nearly $1.2 million in tax-free savings over 30 years.

Starting early and maintaining consistency can have a significant impact. Even without contributing to other accounts, a TFSA of that size has the potential to generate approximately $70,000 in annual tax-free income while preserving the principal. When this income is combined with CPP and OAS benefits, the result is a strong retirement income stream for couples who do not have defined benefit pensions. This approach also helps keep overall taxes low.

Frequent trading.

Speculative investing in a TFSA has become more common with the rise of leveraged ETFs, popular meme stocks, and options trading, but it can lead to serious tax consequences. If the CRA finds that your trading activity resembles a business—such as frequent buying and selling of securities—your gains may lose their tax-free status. In such cases, the CRA can reclassify the income as business income, making it fully taxable. This rule is intended to prevent TFSAs from being used as day-trading accounts. To stay compliant and protect your tax-free growth, it is best to follow a long-term, passive investment strategy.

Taking big risks.

Swinging for the fences with speculative investments in your TFSA, such as investing in penny stocks or securities of companies that are not yet generating earnings, can be a costly mistake since most individual stocks suffer catastrophic losses and never recover. Although gains in a TFSA are tax-free, losses cannot be claimed for tax purposes. This means that high-risk bets offer no tax relief if they fail.

Beyond the immediate financial loss, there’s a significant opportunity cost. TFSA contribution room is limited and valuable. Once lost to a failed investment, that room cannot be recovered. This means missing out on decades of potential tax-free compounding that could have been earned through more stable investments. Protecting your TFSA space by investing wisely ensures you preserve its long-term benefits.

Managing a TFSA in isolation.

A TFSA should be managed as part of a broader investment strategy rather than managed in isolation. Although U.S.-sourced dividends within a TFSA are subject to withholding tax that cannot be recovered, this should not discourage investors from including U.S. dividend-paying securities. Those who avoided U.S. exposure in their TFSA in recent years due to tax concerns may have missed out on significant gains. The focus should be on optimizing total after-tax returns rather than isolating tax efficiency. Including globally diversified growth assets in your TFSA can significantly improve long-term investment outcomes. When the TFSA is thoughtfully coordinated with RRSPs, non-registered accounts, and corporate investments, it becomes a key component of a well-rounded investment portfolio.

Prohibited investments and the advantage rule.

Holding prohibited investments in your TFSA can result in significant tax penalties. The CRA defines these as investments where you have a substantial interest, typically 10 percent or more, or where there is a non-arm’s-length relationship. Examples include owning shares in a private company you control or lending money to related parties. These types of holdings can trigger a 50 percent tax on their value.

In addition, the advantage rule applies to transactions that exploit the TFSA’s tax-free status, such as asset swaps or insider arrangements. If the CRA determines that an advantage has occurred, you may face a tax equal to 100 percent of the benefit received. To avoid these penalties, it is best to stick to qualified, arm’s-length investments like publicly traded ETFs and avoid any strategies that could be considered non-compliant.

Naming a beneficiary instead of a successor holder.

One valuable feature of the TFSA is the ability for spouses or common-law partners to name each other as successor holders. This designation allows the surviving partner to take over the TFSA if one passes away, without affecting their own contribution room and while continuing to benefit from tax-free growth. With a successor holder, the account transfers directly and retains its tax-free status whereas if a spouse is named a beneficiary, the future growth of the assets will be taxed. To take advantage of this option, be sure to name your spouse or common law partner as the successor holder on your TFSA documentation.

In summary, to fully benefit from the TFSA’s long-term growth potential, it’s important to avoid common pitfalls and approach the account with a strategic mindset. While the TFSA offers significant tax-free advantages, those benefits can be diminished without thoughtful asset allocation. Incorporating it into a broader financial strategy and treating it as a long-term investment vehicle allows you to unlock its full potential. Patience and a growth-focused approach are essential, especially as tax-free growth becomes increasingly valuable in a world where tax rates are unlikely to decline.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.


Source: https://www.greaterfool.ca/2025/10/09/the-7-deadly-tfa-sins/


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