The Tax-Free Savings Account (TFSA) is a boon for Canadians as it allows investment income to grow tax-free and be withdrawn tax-free. If you have a knack for long-term investing in growth stocks, this tax-savings account can help you build a million-dollar portfolio without paying any tax. The tax-free withdrawals allow you to claim the maximum Old Age Security (OAS) and other government benefits that have an income threshold.
However, these tax-free withdrawals could become taxable if you do not read the fine print.
Source: Getty Images
Three mistakes that could make TFSA withdrawals taxable
TFSA withdrawals are added back to your contribution room, but not until the following year. Suppose you withdrew $2,000 from your TFSA in May 2024. This amount will be added to your 2025 TFSA contribution room, which will now be $9,000 ($7,000 for 2025 + $2,000 from 2024 withdrawals).
Often, this rule is misinterpreted, resulting in taxable TFSA withdrawals.
1. Transacting between multiple TFSA accounts
You can open a TFSA with more than one bank or financial institution. But this doesn’t mean you can contribute twice the amount. The Canada Revenue Agency (CRA) announces the TFSA contribution limit for each year. For 2025, the TFSA contribution limit is $7,000, which means if you have three accounts, the combined contribution room is $7,000.
Scenario: Suppose you invested $7,000 in TFSA account number 1, withdrew $5,000 from account number 2, and deposited that amount in account number 3. The CRA will count your TFSA contribution as $12,000 ($7,000 + $5,000) even though you just transacted between your TFSA accounts.
It is because the combined contribution of all three TFSA accounts is $7,000, and the withdrawal you made won’t increase your contribution room until next year. Don’t make this mistake of making deposits and withdrawals between multiple TFSA accounts.
2. Making TFSA contributions while outside Canada
The TFSA benefit is only available to Canadian residents. If you go outside of Canada to work, live, or study, check your residence status for tax purposes. As per the 183-day rule, you should spend 183 days or more in Canada in a calendar year for the CRA to consider you a Canadian resident for tax purposes.
Why is this important?
If you make any new TFSA contribution as a non-resident, a tax penalty of 1% per month will apply. If you withdraw from the TFSA while residing abroad, your withdrawal will be subject to foreign taxation. The CRA won’t impose any tax penalty for withdrawals.
Solution: If your job doesn’t allow you to stay in Canada for long, you can opt for a dividend reinvestment option (DRIP) from BCE (TSX:BCE). In a DRIP, BCE automatically reinvests your dividend income and issues income-generating DRIP shares for zero brokerage fees.
The telco has a 4.9% dividend yield. It slashed dividends in July to strengthen its balance sheet and restructure its business. The next two years could be as challenging as it converts from a telco to techno. However, it has the potential to grow dividends in the long term as the 5G opportunity boosts earnings.
Meanwhile, the DRIP can continue to invest while you are abroad.
3. Foreign dividends
You can invest in U.S. stocks through your TFSA and enjoy the tax-free withdrawals. However, dividends from U.S. companies are subject to withholding tax and cannot be recovered even if shares are bought through a TFSA. Hence, opt for U.S. growth stocks to avoid paying withholding tax.
Advanced Micro Devices (NASDAQ:AMD) is a stock you could consider investing in through your TFSA. The semiconductor company has the benefit of a diversified portfolio of central processing units and graphics processing units for computers, data centers, embedded devices, and game consoles. It has also entered the data centre artificial intelligence (AI) space. Trump’s August tariff announcement has pulled the stock down 11% creating a buying opportunity before the holiday season rally.
