A Tax-Free Savings Account (TFSA) indeed sounds like a dream—tax-free growth and flexible withdrawals alongside no age limit for contributions. But as good as it is, the TFSA does come with specific drawbacks that generally catch people by surprise. Before asking, “Do I pay tax on my TFSA?”, it is worth acknowledging where things can go wrong.
We present the lesser-known downsides of a TFSA as below:
If individuals contribute more than the available room, the Canada Revenue Agency (CRA) charges a 1% penalty per month on the excess amount. It does not take much to go over, especially if you forget about previous deposits or re-contribute too early in the same year.
Holding U.S. dividend-paying stocks in the TFSA can generate a 15% withholding tax by the IRS. Instead of RRSPs, TFSAs are not recognized as retirement accounts in the U.S., so recovering this tax is not possible. That is a sunk cost—something to take into consideration for the investment mix. This is in relation to what is commonly referred to as TFSA U.S. stocks tax.
For Americans living in Canada, the IRS does not view the TFSA as tax-exempt. Income earned inside it—no matter if interest or capital gains as well as dividends—needs to be reported. In specific cases, this also means filing Forms 3520 and 3520-A each year and generating IRS TFSA taxation headaches.
It is true that not every asset belongs in a TFSA. Non-qualified investments like specific real estate holdings or private shares can result in penalty fees and unexpected taxation reporting obligations.
In a nutshell, the answer to “Do I pay tax on my TFSA?” is mostly no—for Canadian residents with standard investments. But between TFSA withdrawal tax misconceptions, over-contribution pitfalls, and U.S. tax rules, a few missteps can result in costly outcomes.
For smart TFSA tax strategies or assistance with international tax concerns, Watter CPA is here to assist. Contact us today for full compliance and financial clarity.
