The Tax-Free Savings Account (TFSA) is a special investment account that allows Canadians to invest in qualified investment securities and withdraw the income tax-free. There is no time limit or a maximum amount that you can withdraw. If you have half a million in your TFSA, you can withdraw the entire amount tax-free. However, there are rules that, if violated, could make these withdrawals taxable. You may end up making some easily avoidable mistakes because of ignorance.
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Common mistakes that could make TFSA withdrawals taxable
TFSA contributions can become taxable under certain circumstances.
1. US dividends
A TFSA allows you to invest in US stocks. While capital gains on the sale of US stocks enjoy a tax-free benefit, dividends paid are subject to a 15% withholding tax. The Canada-United States tax treaty allows dividends to be tax-free for retirement accounts, but not for a TFSA.
2. Spouse becomes TFSA beneficiary
The TFSA withdrawals become taxable after the death of the taxpayer, as the account loses its tax-free status. However, a spouse or common law partner can make the withdrawal tax-free if they transfer the TFSA balance by the end of the following year of the TFSA holder’s death and fill out RC240 form within 30 days of transfer.
If your spouse fails to fill out the form, the withdrawals will eat up the partner’s TFSA contribution room, and the balance amount will be considered a surplus contribution and attract a penalty of 1% per month on the surplus.
When creating a TFSA, you could name your common-law partner or spouse a successor instead of a beneficiary to avoid the above risk. A successor can claim the amount in your tax-free savings account without having to fill out a form and giving up their TFSA contribution room. However, a successor can only be your spouse or common-law partner.
3. Non-spousal TFSA beneficiary
A person who is not a spouse can only be a beneficiary. The transfer of your TFSA balance will eat up the beneficiaries’ contribution room, and the surplus amount will be added to taxable income.
Suppose Mary had a TFSA balance of $100,000 at the time of her death. She has named her son as the beneficiary, who has a TFSA contribution room of $60,000. The son will have to pay tax on $40,000.
How to use your TFSA wisely
Any TFSA withdrawals you make can be re-invested in the TFSA in the next calendar year. If you withdrew $5,000 from your TFSA in 2024, it will be added to your TFSA contribution room on January 1, 2025. However, if you reinvest the withdrawals in the same year and you have no TFSA contribution room left from past years, the 1% per month penalty will apply on surplus contributions.
The TFSA is a good tool to earn millions in investment income by investing in high-growth stocks once you understand the rules.
Tech stocks
Some high-growth stocks worth investing in to maximize the tax benefit of this account are tech stocks like Topicus.com (TSXV:TOI) and US stocks like Advanced Micro Devices (NASDAQ:AMD).
Topcius.com uses the power of compounding to increase its enterprise value. It acquires vertical-specific software (VSS) companies with sticky cash flows and uses that cash flow to buy more companies. As more such cash flow streams get added, the annual free cash flow stream broadens and increases the enterprise value. Its free cash flow increased 11% year-over-year in the first half of 2025. The majority of this growth comes from acquisitions, and that growth drives the stock price.
The management acknowledges that Artificial Intelligence (AI) will impact its VSS and is monitoring the trend to adapt to the changes.
AMD, on the other hand, is benefiting from AI adoption. The company has developed AI chips for computers and data centres. It is also working on using its AI chips in industrial robotics. You can benefit from the growing demand for AI devices, computer upgrades, and the maturity of AI technology.
While the above two stocks can be a part of your core portfolio, you can diversify your investments in Canadian Natural Resources for dividends. You can use the dividend money for risky future growth stocks like Ballard Power Systems.
