Episode #11: The Top Four TFSA Pitfalls and How to Avoid Them

In this episode of the Retirement IQ Podcast, host John Stregger breaks down one of the most misunderstood tools in retirement planning: the Tax-Free Savings Account (TFSA). While TFSAs offer tax-free growth and flexibility, John explains that many Canadians make common mistakes that reduce their long-term value.

John begins with a simple overview of how TFSAs work, including how contribution room accumulates, how unused room carries forward for life, and why TFSA withdrawals don’t affect income-tested benefits like Old Age Security.

The episode then explores the four biggest TFSA pitfalls: using a TFSA as a basic savings account instead of an investment, choosing a TFSA over an RRSP when RRSPs may offer greater tax advantages, over-contributing and triggering penalties, and failing to properly name beneficiaries or a successor holder.

With clear guidance and practical insight, this episode shows how smarter TFSA planning can help build tax-free wealth and strengthen your overall retirement income plan.

Transcript

Episode 11: The Top Four TFSA Pitfalls and How to Avoid Them

Hi everyone and welcome to another episode of Retirement IQ where I help you, our listener, simplify the complex world of retirement planning so that you can focus on building the retirement lifestyle that you want to have. I'm your host, John Stregger and today I want to talk to you about the 4 biggest mistakes we see people make with the Tax Free Savings Accounts which are also known as TFSA’s

But before we jump into those mistakes, and to make sure that we are all on the same page, I just want to spend a couple of minutes covering off at a really high level what exactly is a Tax Free Savings Account and what are some of the Key benefits to investing within a TFSA. 

So, what is a TFSA? Simply put, it is a type of investment account where any money you contribute can grow tax‑free for life. You put in money that you’ve already paid tax on (after‑tax dollars), and from that point forward there is No tax on interest, No tax on dividends, No tax on capital gains and No tax when you withdraw. Since you do not have to pay tax on your investment gains, your investments can compound faster over time which ultimately means more money for you! 

Since there is no taxation on withdrawals, from a retirement planning perspective they can also be a great investment tool as any withdrawal you might make won’t impact any income tested pension benefits such as Old Age Security or Guaranteed Income Supplement. 

Now, because TFSA’s are so great for investors, CRA does limit how much you can invest or contribute in a TFSA. TFSA contribution room is the maximum amount you’re allowed to contribute to all your TFSAs without penalty. It increases every year and carries forward for life.

Here are the Key Rules you need to know: 

-              You begin building TFSA room on January 1 of the year you turn age 18

-              Each calendar year adds a new amount to your room. For example, in 2026, CRA allowed Canadians to contribute an additional $7,000 to their TFSA. 

-              If you don’t use your full contribution room this year, the unused amount carries forward with no expiry. 

-              If you withdraw money from your TFSA, the amount withdrawn is added back to your contribution room on January 1 of the next year (not immediately but the room does come back to you).

-              It’s really important not to contribute more than your available room, the CRA charges 1% per month on the excess until you remove it. We’ll dig into this a bit more later 

-              Now if you’ve never owned a TFSA and you were born prior to 1992, then your contribution limit could be as high as $109,000. 

So that’s how it works, Now here are the 4 Biggest mistakes that I see people make with their TFSA accounts. 

Mistake #1: Using your TFSA as a Savings account and not as an Investment Account

A lot of people have the understanding that a tax-free savings account is to be used strictly as a savings account. So, much like when we have a checking account that we use for our day-to-day spending, often at the bank, we'll set up a savings account where we put some extra money whether that's for an emergency fund or just extra cash flow our bigger purchases in the future. So, what's happened since the tax-free savings account was introduced back in 2009 is a lot of people have just used this tax-free savings account for that same purpose. In fact most I believe that most people think that the TFSA is limited to savings accounts because of the name Tax Free SAVINGS Account. I think a lot of people would approach this product differently if the name were instead Tax Free INVESTMENT Account. Using the word Investment would trigger a more long-term bias to the product which is how most people should approach it. So if you are in a situation were you have not maximized your TFSA limits AND you have non-registered investments growing in a taxable environment, you should look at moving those investments into a TFSA to reduce your future taxes payable. 

Mistake #2: Choosing to invest in the TFSA over RRSPs for your retirement savings. 

If you listened to Episode #9 which was titled “I wish I’d never bought RRSPs”, you’ll know that we dispelled many myths surrounding high taxation of RRSPs at retirement. A lot of the time people will tell us how much they hate rsps when they get to retirement because of the tax that they have to pay on that income. For some reason people forget about the massive tax break they receive when they make the RSP contribution when they go to withdraw the money for income. Sure, there will be tax to pay but for the majority of people when you compare the tax payable at retirement on RRSP income versus the tax saved when they make the contribution, the tax benefit is obvious. This is primarily true specifically if you are a high income earner. Most high earners we meet, are destined to be in a lower tax bracket at retirement which makes the case for RRSP’s even stronger.  Also, when you are strategic about your RRSP withdrawals at retirement, there are many ways to draw your RRSP income out at low tax rates.  First off, You have the ability to time your withdrawals to years when your taxable income is low. Secondly, If you are married or in a common law relationship, you have the ability after age 65 to split income with your spouse which has the potential to reduce your taxes dramatically.    So when it comes to using the TFSA vs the RRSP for retirement savings, I would say that in most cases the RRSP is going to be far more beneficial to the TFSA from an overall financial planning perspective.  

Mistake #3 – Over Contributing to your TFSA

This is a mistake that can cost you a lot of money in unnecessary penalty taxes. As we we’ve already mentioned, CRA limits how much you can invest in your TFSA. So what happens if you exceed that limit? Let’s look at an example – Say you come into some money through an inheritance or a lottery win and you had $119,000 to invest. You love the idea of tax free investing so you open a TFSA and invest the full $119,000 in your new TFSA account. Now behind the scenes, CRA has a contribution limit on file for all Canadians. If you had never contributed to TFSA and you are over the age of 35, then your limit is $109,000. If we use this limit in the example, then you just over-contributed by $10,000. This over-contribution isn’t likely to get noticed by CRA for many months at which time they are going to send you a nasty little notice letting you know that you have overcontributed to your TFSA by $10,000. The notice will also tell you that the penalty for your overcontribution is 2% of the $10,000 per month that you’ve overcontributed. That’s $200 per month IN PENALTIES. So if you make this error early in the year, it is very possible to go 12 months before CRA let’s you know about it resulting in 12 months worth of penalties which in our example equals $2,400! How can you avoid this? We recommend to all our clients that they open an online account with CRA. This allows you to look up all things related to your tax situation. You can look up Past Tax returns, notice of assessments, RRSP contribution limits and yes – your TFSA contribution limit. You can also call CRA to get this information but getting through to a live person these days is getting more and more difficult. The online account option is definitely the way to go. 

Once you have your limit information, we strongly recommend opening only one TFSA account. The #1 reason people overcontribute to TFSA accounts is because they open multiple accounts and lose track of their contributions. On more than one occasion, We have clients that had maxed out their TFSA accounts through us but also inadvertently opened a TFSA through their bank on the suggestion of teller when depositing money. When those people come back to us with their nasty CRA notices, it is usually then that we discover that the error was made by a good intentioned mistake but a costly one. Many of these overcontribution situations can be avoided by opening only one TFSA or consolidating all of your TFSA accounts into one so that you or your advisor can keep things compliant. 

Mistake #4-  Improper Beneficiary Designations

One of the great things about tax free savings account is that when we pass away, that it doesn’t have to go into your estate to get to the people you love. So, if it does go into your estate, then it has to go through probate. And in Ontario you can expect the probate fees to be about one and a half%, Furthermore, if the money goes into your estate, that money could be tied up and not passed on anywhere from six months to two or more years, however long it takes to for that estate to be wound up? That can all be avoided with proper beneficiary designations made directly on your accounts, so let’s look at the options. Firstly, if you're in a relationship, so married or common law, you can name a successor holder. The successor holder, if you have that option, that's definitely what you want to choose. Because what that does is if you're the pass away and you're spouse is still living, then your spouse is able to roll in your entire tax free savings account into their tax free savings account. This recently just happened with one of our clients, so we do see this happen. Some of our married clients each have well over 100,000 in their TFSAs. If both of them have over $100,000 in tax free savings accounts and one spouse passes away their entire 100,000 will roll into the other spouses TFSA and now the surviving spouse will have a TFSA worth over $200,000. And there's no tax or probate fee to be paid to make that transition. So that's a great benefit. So what if you are not married or common law? In that case you don't have that successor holder option, but you can name one or more beneficiaries, which is also great because it still allows you to avoid probate and the money passes outside your estate. And so the advantages here really are that it passes quickly to your beneficiary, so that can be family or whomever you want. That payment process should be done in as little as a couple weeks but unlkike the successor option, the money they receive will lose the tax free savings account status but neither your estate you’re your beneficiary has to pay any tax or probate fee. So that's still a really great option. 

The TFSA is one of the simplest and most powerful financial tools available in Canada. It can provide Flexibility, Tax‑free growth, Tax‑free withdrawals, Lots of Investment choice with No impact on government benefits. Whether you’re saving for a short‑term goal or building long‑term wealth, it’s an account almost everyone can benefit from. 

This concludes our 10th episode of Retirement IQ and I hope you are enjoying the show. I know we are having a lot of fun sharing our thoughts on everything retirement and if you want to learn more, come visit us at freeretirementreport.ca, we’d love to hear from you! Until we meet again, I’m John Stregger and thank you for listening to Retirement IQ. Have a great day everybody!