Disadvantages of Using a TFSA
While TFSAs have many advantages and it’s hard to knock their usefulness, there are instances where it is not the best investment option.
Taxable income and refunds
The most obvious disadvantage of a TFSA is the lack of an immediate reduction of your taxable income. With an RRSP you at least get to claim it as an income deduction. With a TFSA you don’t get to do this. The advantage only comes in on the other end (tax-free withdrawals) so if you are looking to lower your taxable income, this isn’t the way to go.
Another often-overlooked aspect is that unlike an RRSP, a TFSA doesn’t contribute towards a tax refund. Because of this, you don’t have the option of immediately investing that refund and enjoying compound interest.
Contribution limit confusion
One of the most common problems with owning a TFSA is the confusion surrounding contribution limits. People constantly over-contribute and end up getting penalized by the CRA. In the early years of the TFSA these “accidents” were often forgiven by the CRA, provided you could prove no malicious intent, but since the program has been around for several years now the CRA is less lenient. So make sure you understand the rules and to be safe, never withdraw and then re-contribute money to your TFSA in the same calendar year. Wait until the next year to be safe!
Contribution limit not enough for you?
The TFSA has a current annual contribution limit of $6500. However, if you have lots of income to potentially invest, you may find this rather restrictive. With an RRSP you can contribute potentially more (18% of your income) up to about $30,000. And if you want to invest oodles of money in a non-registered plan there is no limit at all (although you’ll pay tax on it).
Transfer rules
This is related to the confusion surrounding contribution limits. Basically every time you do a transfer between multiple TFSAs, you will be eating into your annual contribution limit. To avoid this, you must do what’s called a direct transfer, where the bank (or whomever is your TFSA issuer) does the transfer for you. Only in this way can you avoid the accidental over-contribution scenario!
Capital losses
When the investments inside your TFSA do well, you make money. That capital gain is tax-free. However you can’t claim a capital loss if you lose money inside the TFSA. That money is lost forever, you can’t claim it back by subtracting it from a well-performing (taxable) investment outside your TFSA. And you also can’t claim this loss against increasing your contribution room…once you contribute your annual designated amount, that’s it.
US dividend stocks and withholding tax
If you have foreign stock inside your TFSA, you will have to pay a withholding tax. Normally when you have to pay a withholding tax you get to claim the equivalent in a foreign tax credit, essentially cancelling each other out. However the foreign tax credit is not available on TFSA earnings so you have to eat this extra expense. There is a special exemption in place for US dividends going into retirement vehicles such as the RRSP or RRIF, but this does not exist for TFSAs.
High fees
While a TFSA can be a great way to earn tax-free income, if you put that money in the wrong type of investments you could end up losing money over the long term. Mutual funds can especially eat into TFSA income if you invest in ones with high MERs. And if you like to make numerous trades you could be hit with lots of commission fees or transaction fees. Do your homework to make sure you are investing in the right sort of funds for your financial situation!
14 Comments. Leave new
Just wondering what age group you consider to be “at the end of their life”. Are you referring to people who are already retired? You used this term when addressing a question regarding who should not invest in TFSAs. I am in the throes of deciding whether to invest in more.
Hi Nikki,
We really were referring to someone who is in the final years of living, not a person who is simply retired. People in their final years of life are unlikely to be saving money (as most Canadians at the end of their lives are spending what they have), and if in some special scenario they have excess funds coming in, ensuring compliance with TFSA rules could prove to be an unnecessary burden. However, there may be unique situations where a TFSA could still prove to be appropriate for a person in this position.
Everyone’s individual tax situation is unique and can potentially carry complications. Best to consult a tax professional or at the very least, have a thorough understanding of what you can and can’t do with your TFSA if you think it may be disadvantageous to add more money to yours.
How do I avoid triggering Day Trader flags in a TFSA? I’m doing buy-writes that mature every 3-6 months. What profit levels trigger an audit? (Probably will never make that kind of money, but just asking in case I have a great year sometime!)
How are profits tracked by CRA?
Hi Kelly,
It’s up to CRA to decide what constitutes day trading – there doesn’t appear to be a formal definition for what they mean by this, so there is a lot of ambiguity. If you work in finance and are using your TFSA for complicated investments, a red flag could potentially triggered.
It also appears that CRA has red flagged accounts nearing 1 million. This link may help: https://www.moneysense.ca/save/investing/tfsa/taxman-after-your-tfsa-unlikely/
My TFSA is currently not doing well. I’m currently running at a loss. What do I do?
Hi Omotayo,
Sorry to hear about your situation. Unfortunately, one downside of TFSA accounts is that if you have holdings that you have lost money on, you cannot claim any capital gains losses on them (as you would on other types of accounts). So essentially, the trade off you make with investments inside your TFSA is that although any gains you have are able to be enjoyed tax free, you cannot write off any losses.
Who should not open a TFSA?
Hi Eve,
Good question. There might be unique circumstances that make it disadvantageous for someone to open a TFSA (such as being at the end of their life, being heavily in debt, etc.), however for the vast majority of Canadians who are 18+, and have some savings, TFSA’s are the single most powerful investment tool at their disposal.
I bought stocks in my TFSA last month and would like to take profit and put it on other stock? Is this safe I mean would I pay taxes because I did a short term trade?
Hi Gab,
If you took profits from a trade done within your TFSA, and with the proceeds, purchased another stock within your TFSA account, you wouldn’t have to pay any taxes.
If you are doing this constantly and are considered a day trader by CRA (and are therefore using your TFSA as a way to operate a business), then you might raise some red flags. Otherwise, we are no aware of any set minimums on how long you need to own a stock for within your TFSA.
I’m living in Canada since 2012. I opened tfsa in 2 banks but I put money in 1 bank only. In 2019 I deposited in a random time like I deposited 2k in July again 6k in July and again 4k in September. I know I crossed my contribution room for 2019 but I haven’t crossed my contribution room. Is there any chances to get penalties if I do so?
Hi Naylax,
If your to-date unused total contribution room available is more than the 12k you deposited this year (which sounds like it is, assuming this is your first contribution since 2012), then there shouldn’t be a penalty for your deposits. Please call CRA directly to check what your total to-date total contribution limit is: 1-800-959-8281.
I came to Canada in October 2017. Can I contribute all the $5,500 allowable for that year even though I was only in Canada for effectively 2 months?
Hi Adrian,
The way we understand it, you should be able to contribute the full $5,500 for 2017, even though you were not a resident for the full year; for simplicity sake, contribution room is dependent upon the year you arrived – the month doesn’t matter.