Written by Christopher Liew, CFA at The Motley Fool Canada
The Tax-Free Savings Account’s (TFSA) two remarkable features, tax-free money growth and withdrawals, make it the ultimate wealth builder. It’s also a retirement savings account like the Registered Retirement Savings Plan (RRSP), but better. It has no age limit or never expires. You can contribute and earn tax-free as long as you can and want.
Remember, the Canada Revenue Agency (CRA) is watching. You can get in trouble if you violate the rules and pay taxes when you don’t have to. Compliance with rules is the key to building wealth in a TFSA and being problem-free.
The CRA sets annual TFSA contribution limits, and therefore, it follows that you can’t exceed the limit. You risk paying a tax of 1% per month on the excess amount. Some users inadvertently overcontribute, while others bend the rules or do it intentionally
The taxman grants relief for reasonable errors or overcontribution by accident but frowns and imposes harsh penalties on perennial contributions above the allowable limit.
Carrying a business
The tax agency is hunting for day traders or users that carry on a business in their TFSAs. Aggressive trading or buying and selling stocks to gain an advantage or make fast money is a red flag for CRA auditors. If found guilty of the offence, all gains could end up as business income and be taxed accordingly.
Some Canadian investors prefer investing in foreign assets or stocks for diversification. The CRA allows investments in U.S. dividend-paying companies and other stocks in designated exchanges, but earnings are subject to withholding taxes.
If you insist on adding American stocks, the recourse is to hold them in an RRSP instead. The Internal Revenue Agency (IRS) grants tax exemption on the RRSP but not the TFSA.
Obedient TFSA investors can completely prevent CRA’s intervention by owning dividend growers or Dividend Aristocrats. The companies in the prestigious group have raised their dividends for at least five consecutive years. TELUS (TSX:T), in the communications services sector, is a sound choice for dividend earners.
Canada’s second-largest telecommunications company has a dividend growth streak of 19 years. The dividend payout is quarterly; if you invest today ($23.77 per share), the dividend offer is 6.33%. TELUS recently raised its dividend by 7.1%.
Assuming you use the 2023 $6,500 TFSA limit to purchase this 5G stock, you will generate $411.45 in annual dividends. If you reinvest the dividends as you receive them, the money will compound tax-free to $12,180.62 in 10 years.
In the third quarter (Q3) of 2023, the $34.6 billion company’s telecom customers grew 17% to 406,000 versus Q3 2022, an all-time quarterly record. The 160,000 Mobile Phone net addition was the best third quarter on record. While net income dropped by 75.1% year over year to $137 million because of restructuring and other costs, free cash flow rose 7.3% to $355 million.
Its president and chief executive officer, Darren Entwistle, said the significant broadband network investments will advance TELUS’s financial and operational performance. It also assures the long-term sustainability of the dividend-growth program.
Just follow the rules
Everything is tax-free in a TFSA, unless users themselves break the rules or abuse the perks that come with the unique investment account.
The post TFSA Investors: How to Build the Most Wealth Without the CRA Checking on You appeared first on The Motley Fool Canada.
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