The Tax-Free Savings Account (TFSA) is a unique tool that helps Canadians generate tax-free wealth. Unlike a Registered Retirement Savings Plan (RRSP), a TFSA has no end age limit that you can only invest till age 70 and no withdrawal limit. Also, it allows you to recontribute the amount you have withdrawn in the next tax year.
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Why are TFSA withdrawals taxable?
What’s unique about TFSA is that the withdrawals you make need not be reported as taxable income. So, if you have a million-dollar TFSA, which is possible if you invest in high-growth stocks, you can withdraw that entire amount and do not need to report it as taxable income.
How is it possible? Because you invest the after-tax income in your TFSA. And the Canada Revenue Agency doesn’t allow you to invest in high-risk investment instruments that are more prone to losses, like options trading or cryptocurrency.
A few small mistakes can make TFSA withdrawals taxable
However, the tax benefit of TFSA has certain rules, which, if broken, can make the withdrawals taxable.
Recontributing TFSA withdrawals in the same year
The CRA allows Canadians to recontribute the amount withdrawn from a TFSA in the next tax year. The Agency updates the TFSA contribution room on January 1, where it adds back the previous year’s withdrawal. If you withdrew $5,000 in 2024, your contribution room will update to $12,000 on January 1, 2025 ($5,000 + the 2025 TFSA contribution of $7,000). If you recontribute that $5,000 in the same year and you don’t have enough contribution room, the CRA will treat it as an over-contribution. It will impose a 1% penalty every month on the over-contributed amount until withdrawn.
Another precondition is that you need to be a Canadian resident when recontributing. The TFSA withdrawals will be added back to your TFSA contribution room in the following year, even if you are a non-resident. However, you cannot recontribute until you re-establish Canadian residency.
When you withdraw funds, you miss out on the opportunity to earn tax-free returns that money could have earned had you stayed invested. You can minimize the opportunity cost by withdrawing closer to the end of the tax year.
Transacting between multiple TFSAs
Many Canadians open multiple TFSAs with different financial institutions. Having multiple accounts does not affect the contribution room, as that is per Canadian and not per TFSA. If you withdraw $5,000 from one TFSA and contribute it to another TFSA, that will be treated as a contribution.
Instead, you could ask the financial institution to do a direct transfer to avoid counting it as a TFSA withdrawal. A good practice is to consolidate all accounts and have only one TFSA, as it is easier to manage.
TFSA withdrawals on prohibited investments
The CRA has a list of qualified investments for TFSA, which excludes assets and property where you have a personal interest, like shares of a company where you have a significant interest, crypto coins, and day trading. These prohibited investments will attract a tax of 50% on the investment value and capital gain tax on any income from these investments.
Foreign taxation
TFSA tax benefit is offered by the CRA, but it is subject to foreign taxation.
TFSA allows you to invest in U.S. stocks and get tax-free withdrawals. However, withholding tax is levied on dividend income on U.S. stocks even if they are held in a TFSA. Another foreign tax is when you make TFSA withdrawals while residing abroad. The CRA won’t tax the TFSA withdrawal, but the country you are staying in might, making it taxable.
How to invest smartly in TFSA
You can make the most of TFSA’s tax benefits by investing in high-growth TSX stocks like Constellation Software (TSX: CSU). The company is a private equity firm of software companies. It keeps acquiring vertical-specific software companies with stable free cash flow from maintenance services.
The stock has dipped 28% since September when its founder, Mark Loenard, resigned due to health reasons. However, Constellation continues to report double-digit revenue and free cash flow growth in the third quarter of 2025, hinting that the market may have overreacted to the resignation, making it a perfect TFSA stock.
