Breaking your tax-free savings account (TFSA) account rules is a great way to be taxed when you least expect it. We expect TFSA returns to be tax-free – it’s in the account’s name after all – but if we play fast and loose with the rules, we may end up being taxed on TFSA holdings.
In this article, I share the stories of three Canadians who violated TFSA account rules and got taxed on their holdings. I will keep the individuals’ names anonymous; you can find more details on their stories by Googling keywords from the short stories below. I’ll also provide some advice on how to avoid their fate(s).
Source: Getty Images
Case #1: Woman uses swaps to turn $5,000 into $200,000 – gets taxed
In 2019, a woman lost her appeal after the Canada Revenue Agency (CRA) taxed her TFSA for day trading and she challenged the tax bill. What this individual did was use swaps to turn a $5,000 TFSA into a $200,000 nest egg. She was found to have been carrying out business activities in her TFSA and was taxed accordingly. The fact that she challenged the CRA in court and lost illustrates the authority’s attitude toward Canadians using swaps and other derivatives to achieve outsized TFSA profits. Basically, it’s not friendly towards them.
Case #2: Redditor over-contributes
Last year, an anonymous Canadian took to Reddit to share his story of having over-contributed to his TFSA in 2023. He calculated his over-contribution penalty at $30 and stated that he intended to pay it. This individual may have some luck getting the taxes waived by the CRA if he reports the situation promptly. However, more serious and long-term cases of over-contribution can result in significant penalties.
Case #3: Former trader amasses $1.25 million TFSA – CRA comes knocking
In 2015, the Financial Post reported the story of a former professional trader who reached a $1.25 million TFSA balance. The CRA found out about about it and decided that he was on the hook for taxes. Like the person in case #1, this individual challenged the CRA in court and lost on appeal.
What to do about it
If you have a large TFSA balance, there are three things you can do to protect your account from taxation:
- Do not over-contribute. Stay within your contribution limit; you can find it on CRA MyAccount.
- If you’re self-employed, don’t try to turn your business into a security and deposit the security in your TFSA. This is a surefire way to get taxed.
- Do not day trade in your TFSA, especially not full time using expensive research services and trading software.
The last item on the list above is especially worth noting. Day trading full time in a TFSA can result in some very steep taxes. Of the three cases discussed above, it was day traders/options traders who got hit with the biggest taxes; the over-contributor paid a mere $30 penalty.
Instead of day trading in your TFSA, you should passively invest in low cost ETFs like the Vanguard FTSE All-Cap Canada ETF (TSX:VCN). VCN is an ultra-diversified ETF that tracks 98% of the Canadian stock market. Its universe of stocks is quite large (161), though smaller than that of a TSX index funds (220). Its management fee and management expense ratio are both 0.05%, which is fairly low. And finally, the fund is fairly liquid with a small bid-ask spread. Overall, it’s a great passive fund to consider. Certainly, it beats day trading in your TFSA.
