Aberrant aggregation of the RNA-binding protein TDP-43 in neurons is a hallmark of frontotemporal lobar degeneration caused by haploinsufficiency in the gene encoding progranulin1,2. However, the mechanism leading to TDP-43 proteinopathy remains unclear. Here we use single-nucleus RNA sequencing to show that progranulin deficiency promotes microglial transition from a homeostatic to a disease-specific state that causes endolysosomal dysfunction and neurodegeneration in mice. These defects persist even when Grn-/- microglia are cultured ex vivo. In addition, single-nucleus RNA sequencing reveals selective loss of excitatory neurons at disease end-stage, which is characterized by prominent nuclear and cytoplasmic TDP-43 granules and nuclear pore defects. Remarkably, conditioned media from Grn-/- microglia are sufficient to promote TDP-43 granule formation, nuclear pore defects and cell death in excitatory neurons via the complement activation pathway. Consistent with these results, deletion of the genes encoding C1qa and C3 mitigates microglial toxicity and rescues TDP-43 proteinopathy and neurodegeneration. These results uncover previously unappreciated contributions of chronic microglial toxicity to TDP-43 proteinopathy during neurodegeneration.