A Guide to TFSA Withdrawal Rules and the Tax Implications

TFSA contribution rules

A TFSA stands as a cornerstone for Canadians seeking to grow their savings without paying tax on the income earned in the account. 

If you’re over 18 and have a valid social insurance number (SIN), you’re eligible to open a TFSA. For younger individuals navigating significant life changes, a TFSA offers financial flexibility without immediate tax implications. 

Central to managing your TFSA is understanding your contribution room. For 2023, the TFSA limit is $6,500. This means you can contribute $6,500 to your TFSA in 2023, and the income earned on that $6,500 will be tax-free.

Contribution room carries forward, so if you haven’t contributed to your TFSA in a prior year, you can invest the cumulative amount from the time you were eligible to open a TFSA.

For example, let’s say you turned 18 in the year 2018, but you just learned about the TFSA in 2023. That means your TFSA contribution room would be $6,500 for 2023, $6,000 each for 2019 to 2022 (4 x $6,000 = $24,000), and $5,500 for 2018.

Because you haven’t made any contributions to your TFSA yet, your contribution room in 2023 is $36,000 ($6,500 + $24,000 + $5,500 = $36,000)!

Regaining contribution room

Unique to TFSAs is the ability to recontribute what you withdraw. If you take out $2,000 one year, that amount is added to your contribution room for the next year. This means if you withdrew $2,000 in 2022, in 2023 you can contribute up to $8,500 ($6,500 + $2,000 = $8,500).

Because TFSAs are a unique investing vehicle, they come with their share of questions. Here are some of the most popular.

Is there a limit on how much you can withdraw from a TFSA?

There’s no limit on how much you can withdraw from your TFSA. Contrary to popular belief, withdrawing from your TFSA is simple and doesn’t incur immediate penalties or taxes. Whether you’re cashing in on investments or need quick cash, your TFSA is designed for flexibility. 

Note: there are some complexities that may arise through investment vehicles which may limit flexibility (like term deposits and GICs) or charge penalties on withdrawal as is the case for mutual funds. 

Do you get taxed if you withdraw from your TFSA?

Regular withdrawals aren’t taxed, but contributing beyond your limit or making contributions as a nonresident can lead to penalties. Keeping up on the current contribution limits can prevent costly surprises.

Can you withdraw money from your TFSA without penalty?

The simple answer is yes; you can withdraw money from your TFSA without facing immediate financial penalties or taxes on the withdrawn amount. This feature is what makes TFSAs highly flexible and user-friendly, especially in comparison to other savings plans. Whether it’s for an emergency, a large purchase, or an unexpected life event, your funds are readily accessible.

However, it’s essential to note that withdrawing doesn’t increase your TFSA contribution room until the following year. For instance, if you withdraw $1,000 in 2023, you have to wait until 2024 to get that contribution room back. It’s critical that you remember this, so as to avoid over-contributing in a given year.

Does selling a stock in a TFSA count as a withdrawal?

Selling a stock within your TFSA does not count as a withdrawal. Within the shelter of your TFSA, you can sell stocks, bonds, or any other investments without the transaction affecting your contribution room.

The proceeds from the sale remain in your TFSA as cash assets. Such transactions don’t count as withdrawals unless you physically remove funds from your TFSA account and place them into a non-TFSA bank account, such as a chequing or savings account.

Do TFSA withdrawals count as income?

No, funds withdrawn from your TFSA do not count as taxable income. This rule applies to any gains from your investments as well. Whether you’ve earned income from interest, dividends, or capital gains, these earnings are tax-free, and withdrawing them doesn’t change that status. 

What are the cons of withdrawing from a TFSA?

While TFSAs are flexible, strategic planning is still crucial. Withdrawing funds means potentially missing out on tax-free investment growth, especially if these funds are not recontributed in subsequent tax years.

Each withdrawal could represent a lost opportunity for your money to grow, as the funds taken out are no longer accruing interest or investment returns within the TFSA. Therefore, if possible, it’s wise to replace the withdrawn amount in the following year or as soon as your financial situation allows, to continue maximizing the tax-free growth potential of your TFSA.