The Canada Revenue Agency (CRA) introduced the Tax-Free Savings Account (TFSA) in 2009 to encourage Canadians to save. The way TFSA works you contribute after-tax income in your TFSA, and the CRA allows you to invest that money in publicly listed securities. Your money can grow tax-free, and your withdrawals are also tax-free. This very feature of TFSA makes it a suitable account to invest in growth stocks that can generate wealth in the long term. Moreover, this tax benefit also extends to U.S. stocks listed on the New York Stock Exchange. However, not all investments can grow tax-free, and not all Tax-Free Savings Account withdrawals are tax-exempt.
This article will discuss scenarios when the CRA can tax your TFSA income and withdrawals.
Scenarios When the CRA Can Tax Your TFSA
Taxation is complex. The objective of the TFSA is to give Canadians an extra income source or wealth generation exempt from tax. However, to avoid misuse of this benefit, the CRA imposed restrictions not in line with the objective. The tax benefit depends on where, how much, and how you invest.
Where to Invest?
Tax-Free Savings Account provides tax benefits only to qualified investments, which include money and securities listed on a designated stock exchange.
The Income Tax Act defines “qualified investment” as:
- Money, GICs, and other deposits
- Most securities listed on a designated stock exchange, such as shares of corporations, warrants, and options, units of exchange-traded funds (ETFs), and real estate investment trusts (REITs)
- Mutual funds and segregated funds
- Canada Savings Bonds and provincial savings bonds
- Dbt obligations of a corporation listed on a designated stock exchange
- Debt obligations that have an investment-grade rating
- Insured mortgages or hypothecs.
Investment securities such as cryptocurrencies and non-fungible tokens (NFTs) do not qualify for TFSA tax benefits. If you invest in such non-qualified securities, the CRA will charge a penalty of 50% of that investment’s fair market value and tax the income and capital gain generated from them.
If you have invested in non-qualified securities through your TFSA, sell them immediately. However, if you invested in a cryptocurrency ETF trading on the TSX, your investment could qualify for tax benefits. It is better to consult a tax expert and review your Tax-Free Savings Account investments to ensure they qualify for the tax benefits.
Tip: You could consider investing in high-growth stocks listed on the TSX and NYSE for the long term and reinvest any dividends to take advantage of the power of compounding. Staying invested long-term in publicly traded securities could reduce the chances of the CRA taxing your TFSA.
How Much to Invest?
TFSA tax benefits are limited to the contribution limit set by the CRA. Every year, the CRA adds a new contribution limit. For 2025, it is $7,000. This limit is added to your TFSA contribution room. The TFSA contribution room comprises unused contributions from past years, any withdrawals in the past year, and the unused contribution limit of the current year.
For instance, Jacob turned 19 in 2024, making him eligible for TFSA. The TFSA contribution limit in 2024 and 2025 is $7,000 each year. He contributed $6,000 last year and withdrew $500.
Unused contribution from 2024 = $1,000 ($7,000 -$6,000)
Withdrawals in 2024 = $500
Unused contribution limit of 2025 = $7,000
Jacob’s 2025 TFSA contribution room = $8,500
If you invest even $1 above your TFSA contribution room, the CRA will charge a 1% monthly penalty on the surplus amount. Moreover, the investment income earned from the surplus contribution will be added to your taxable income.
Tip: Plan your TFSA investments and withdrawals strategically to avoid overcontributing. If you see an investment opportunity and have exhausted your Tax-Free Savings Account contribution room, consider selling low-return securities and allocate that money to qualified investments that generate higher returns.
How to Invest in a TFSA
The CRA uses TFSA to encourage longer-term investments. However, if you use it for trading or to make frequent short-term investments for a few months, that income could be taxed under business income. It is a subjective call as the CRA has no guidelines on how frequently one can transact in the TFSA. However, frequent selling of stocks, frequent withdrawals, and extraordinary growth of your TFSA balance could indicate a business activity and attract CRA’s attention.
Other factors that could indicate a business activity in the TFSA include:
- If you take debt to purchase securities, transfer them to your Tax-Free Savings Account.
- If your TFSA securities are speculative or do not distribute dividends.
The CRA might also question your TFSA holdings if you have extensive knowledge of or experience in securities markets and spend significant time studying the market. These are the signs of a business.
If the CRA identifies your TFSA activity as business during a tax audit, you will have to report income from that activity as business income and pay tax on the same.
Tip: Avoid selling securities in a few months and avoid frequent withdrawals from your Tax-Free Savings Account. However, you could consider making regular monthly, quarterly, or weekly contributions in TFSA up to the contribution room.
Estate Planning with TFSA
While the Tax-Free Savings Account withdrawals are tax-free for the TFSA owner, they may be taxable to their heirs if the heir is not a “Successor Holder.” According to the CRA, a successor holder of a tax-free savings account is the spouse or common-law partner of the TFSA owner. You can also designate someone else, maybe children and grandchildren, as successor holder in your Will or by filing the designation to the financial institution maintaining your TFSA.
Suppose no successor holder is appointed at the time of the original Tax-Free Savings Account holder’s death. In this case, the fair market value of the TFSA can be transferred to a beneficiary’s Tax-Free Savings Account as an exempt contribution, provided it occurs before December 31 of the year following the original holder’s death. Any income earned after the original holder’s date of death is taxable.
Contact Glenn Graydon Wright LLP in Oakville to Help You with Tax Planning
What appears tax-free could become taxable if requirements are not fulfilled. Talk to a professional tax consultant to identify several tax-efficient ways to invest and spend. The value and tax savings an expert brings to the table are far greater than his/her fees. To learn more about how Glenn Graydon Wright LLP can provide you with the best tax planning expertise, contact us at 905-845-6633 or connect with us online to schedule an initial consultation.