Can I Withdraw From a TFSA? What You Need to Know

Tax-Free Savings Accounts (TFSAs) are a popular Canadian savings and investment vehicle, known for tax-free growth and withdrawals. However, U.S. individuals should understand that TFSAs are not available to U.S. residents or citizens in the same way they are in Canada. This article clarifies what a TFSA entails and its implications for U.S. individuals.

Understanding TFSA for U.S. Citizens

For U.S. citizens, including those residing in Canada, the tax-free status of a TFSA under Canadian law does not apply to U.S. tax obligations. The Internal Revenue Service (IRS) views TFSAs as foreign trusts for U.S. tax purposes. This means income earned within a TFSA, such as interest, dividends, or capital gains, is taxable in the U.S., even if it grows tax-free in Canada.

U.S. individuals holding TFSAs are subject to U.S. reporting requirements. This includes filing IRS Forms 3520, “Annual Return To Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts,” and Form 3520-A, “Annual Information Return of Foreign Trust with a U.S. Owner.” Failure to file these forms, or filing them late, can result in penalties of $10,000 or more.

U.S. Tax Implications of TFSA Activity

The primary benefit of a TFSA in Canada is that all income earned within the account is tax-free, and withdrawals are also tax-free. However, for a U.S. citizen, this tax shelter is not recognized by the U.S. Internal Revenue Code. Consequently, any investment income or capital gains generated within a TFSA held by a U.S. citizen is subject to U.S. taxation. This negates the tax advantage intended by the TFSA for Canadian residents.

While foreign tax credits may offset some U.S. tax liability if Canadian taxes are paid on other passive investments, the compliance burden for U.S. citizens remains substantial. Annually reporting TFSA activity to the IRS adds complexity and potential cost through tax preparation fees. For many U.S. citizens, holding a TFSA may result in increased administrative effort and potential tax liabilities rather than the intended tax savings.

Alternatives for U.S. Savers

Since TFSAs are not a U.S. savings vehicle, individuals in the United States looking for tax-advantaged savings options should explore domestic alternatives. The Roth IRA is considered a U.S. equivalent to the Canadian TFSA due to similar tax treatment. Contributions to a Roth IRA are made with after-tax dollars, and qualified withdrawals, including earnings, are tax-free.

Other tax-advantaged accounts available in the U.S. include traditional IRAs and employer-sponsored plans like 401(k)s. While traditional IRAs and 401(k)s offer a tax deduction for contributions, withdrawals in retirement are taxed. These U.S. accounts provide pathways for individuals to save for retirement or other financial goals while benefiting from tax deferral or tax-free growth on their investments.