Don’t Let These Mistakes Cost You: TFSA Withdrawals and Taxes

Don’t Let These Mistakes Cost You: TFSA Withdrawals and Taxes

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 age limit for contributions

• Has no restriction on withdrawals

• Allows you to recontribute the amount you have withdrawn in the next tax year

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Why Are TFSA Withdrawals Taxable?

The unique feature of a TFSA is that withdrawals do not need to be reported as taxable income. Even if your TFSA grows to a million dollars, you can withdraw the entire amount without paying taxes.

Why is this possible?

• You invest after-tax income in a TFSA.

• The Canada Revenue Agency (CRA) restricts high-risk investments like options trading or cryptocurrencies.

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Common Mistakes That Can Make TFSA Withdrawals Taxable

Even though TFSA offers tax-free growth, breaking certain rules can trigger taxes. Here are the most common pitfalls:

1. Recontributing TFSA Withdrawals in the Same Year

The CRA allows recontributions only in the following tax year.

Example:

• You withdrew $5,000 in 2024.

• Your contribution room for 2025 becomes $12,000 ($5,000 + $7,000 TFSA limit for 2025).

• If you recontribute the $5,000 in 2024 without enough room, you will be penalized 1% per month until corrected.

Important:

• You must be a Canadian resident to recontribute.

• Withdrawals are added back to your contribution room next year, even if you were a non-resident.

Tip: Withdraw closer to the end of the year to reduce opportunity costs from missing out on tax-free returns.

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2. Transacting Between Multiple TFSAs

Many Canadians open multiple TFSAs across different institutions.

Warning:

• Contribution room is per individual, not per account.

• Moving money from one TFSA to another without a direct transfer counts as a new contribution and can cause over-contribution penalties.

Best practice: Consolidate accounts and request direct transfers between institutions.

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3. TFSA Withdrawals on Prohibited Investments

The CRA restricts certain assets in TFSAs, such as:

• Shares of companies where you have a personal interest

• Cryptocurrencies

• Day trading

Penalty: 50% tax on the investment value plus capital gains tax on income from these assets.

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4. Foreign Taxation

TFSA is tax-free under Canadian law, but foreign taxation may apply:

• U.S. stocks: Dividend income is subject to withholding tax even in a TFSA.

• Non-resident withdrawals: Your TFSA withdrawal may be taxed by the country where you live, although CRA does not tax it.

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How to Invest Smartly in TFSA

Maximize tax-free growth by choosing high-quality, high-growth stocks.

Example: Constellation Software (TSX: CSU)

• Private equity firm acquiring vertical-specific software companies

• Stable free cash flow from maintenance services

• Stock dipped 28% due to founder resignation, but company continues to report strong revenue and cash flow growth

Tip: High-growth, undervalued stocks can help your TFSA grow faster, making withdrawals truly tax-free.

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Should You Invest $1,000 in Constellation Software Inc. Now?

Before investing, consider the Motley Fool Stock Advisor Canada top picks.

• Their top 15 stocks are identified to deliver strong long-term returns.

• Historical example: $1,000 in MercadoLibre in 2014 grew to over $21,000.

Reminder: Always diversify and research before buying individual stocks.