We are big fans of Tax-Free Savings Accounts (TFSA) here at Endeavour Wealth Management. The only bone we have to pick with these accounts is the fact they’ve been named “savings” accounts, when in reality they are so much more.
Investors should really think of their TFSA as a tax-free “investment” account that can hold a variety of investments. Although you don’t receive a tax deduction for contributions like you would an RRSP, any eligible investments within the account both grow and can be withdrawn tax free! This makes TFSAs an amazing tool investors can use to grow and compound their wealth into hundreds of thousands of dollars overtime.
In many cases a TFSA should most definitely be a part of an individual’s investment and savings strategy. Although it’s often a “no brainer” for investors to have a TFSA, there are various rules and intricacies that investors should be aware of to ensure they are utilizing these accounts the best they can. With that in mind I figured I’d highlight some of the key mistakes I’ve watched investors make when contributing and investing in a TFSA.
A TFSAs annual contribution limit when introduced back in 2009 was $5000. If you were 18 years of age or older in 2009 you would have earned $5000 of contribution for the year. Since then this number has increased adjusting for inflation. For each additional year after the age of 18, investors receive additional contribution room. Any unused room is carried forward and can be used at any time. Today, any person who was 18 years or older in 2009, would have a maximum contribution amount of $69,500 available to them. But no more than this! Until next year of course.
Investors really need to be careful when contributing that they don’t overcontribute beyond what they are allowed because the penalties are steep. CRA will charge 1% on the amount that was overcontributed for EVERY MONTH that you’re over your limit. Investors either have to withdraw funds from their TFSA or wait until more contribution room becomes available before this penalty is lifted.
Often overcontributing occurs due to one of two mistakes. The first is when an individual comes into a windfall of cash and looks to contribute the maximum amount without realizing what their true total contribution room available is. The second is when individuals withdraw money out of their TFSA only to recontribute it back within the same year. The TFSA does allow you to recontribute money that was withdrawn, but you don’t receive that contribution room back until the following calendar year.
Owning US Dividend Paying Companies Inside a TFSA
We almost always recommend to clients that they should own US assets. They reality is that there is just a lot more companies, from a more diverse group of industries to invest in when it comes to our neighbours south of the border.
Investors should be careful if they’re investing into US dividend paying companies and if they can, they should avoid holding them inside their TFSA. The reason being is that any US dividends received within a TFSA come with a 15% withholding tax applied to the dividends received.
We typically recommend holding any US dividend paying investments inside an RRSP. With RRSPs, the IRS views these accounts similar to their 401(k)s, which are meant to provide tax-deferred pension or retirement benefits. CRA has agreement with the IRS which allows US dividends to avoid tax when held within an RRSP.
As portfolios grow in value it can be difficult to ensure that all US dividend paying companies end up inside your RRSP, however if investors have the option, it’s most definitely recommended.
Fun Money Investments Inside a TFSA
We have a number of clients who enjoy getting a little risky with a small portion of their portfolio and attempt to make some short-term bets on companies that we here at Endeavour would consider very high risk. We don’t mind this as long as the investor understands the possibility of losing money is high and if they lose this money that it does not have a significant impact on their overall financial stability.
The mistake is not making a risky bet in this case, the mistake actually lies in the fact the investment was purchased inside the TFSA. Investors’ general hope is that they’ll be able bag themselves an investment that multiplies their money 10x and they won’t have to pay any tax. In theory it sounds great. More often than not the investment either significantly loses value or goes to zero all together.
Remember that your TFSA allows you to withdraw money and recontribute it back into the TFSA the next calendar year. If investors permanently lose money inside the TFSA, both the money and the TFSA contribution room is now gone forever. Inside an RRSP this would not have mattered because you don’t receive any RRSP contribution room back when you withdraw any funds. In a non-registered account, investors would at least have had the opportunity to use the loss to reduce taxes of any capital gains that occurred in the past three years or against any capital gains indefinitely into the future.
TFSAs are wonderful accounts that allow investors to compound their wealth without having to pay any tax. Not fully understanding the rules to TFSAs can cost investors money and leave them with less in their pockets. With a little planning, this can be avoided ensuring investors end up with more money for the things they hope to spend it on in the future.
- Brandt Butt, Investment Advisor, CIM®
Brandt Butt is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Brandt Butt who is an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.