Why your TFSA needs a successor holder

Last time, we looked at the power of Tax-free Savings Accounts (TFSAs) in optimizing low- or un-taxed income for retirees and near-retirees. We touched on the estate planning aspects of TFSAs, stressing the importance of designating your spouse as a “Successor Holder.” We also said we’d look at what happens upon death if that administrative detail is not attended to in advance.

According to estate planning expert and author Sandy Cardy, a poll conducted in 2009 by her former employer, Mackenzie Investments, found there is very little understanding of what happens to TFSAs at the time of death. Seven years later, Cardy says there continues to be a lack of understanding of this topic. Given that many TFSA holders are seniors, it’s important for them to understand the estate planning implications of this investment vehicle.

The first thing to know is that regardless of who the beneficiary is, it’s all tax-free until the point of death. Where it gets tricky is what happens to funds in the TFSA after the TFSA holder dies, and that depends on who the funds are given to and the relationship the beneficiary had with the deceased.

• How to win using annuities in retirement »

As noted earlier, the optimum thing if you are a spouse or Common-law partner (CLP) is to name each other as Successor Holders to the partner’s TFSA, while both are still alive. So if the husband dies, the wife steps in and gets all the rights related to his TFSA. It’s seamless: the account doesn’t dissolve, the wife in this case just becomes the account holder, with no tax consequences.

Cardy points to a TFSA primer prepared by Mackenzie, which says a “Successor Holder” simply continues to hold your TFSA and underlying investments after your death. The Income Tax Act says that once a Successor Holder has been named, “Your TFSA will not terminate on your death: your successor simply replaces you as plan holder, and the plan will continue with all rights passing to the Successor.”

Note that only spouses or Common-law partners can be named Successor Holders. Any TFSA over-contributions made after your untimely demise will be deemed contributions by your Successor in the month after your passing. If the Successor Holder has sufficient TFSA contribution room to absorb the contributions, over-contribution penalties (of 1% per month) will cease.

But what of the trickier situation when death occurs without a Successor Holder having been designated? According to Cardy, If spouses or common-law partners inherit your TFSA, either as named beneficiary of the TFSA application or inherited in accordance with the terms of the deceased’s will, they can transfer the assets to their own TFSAs as long as this occurs during what’s called a “Rollover Period.” This rollover period allows for continued tax sheltering of the investment income; it begins at the day of death and continues until December 31^st of the following year. Transfers that take place during this rollover period are defined as “exempt contributions” and do not require TFSA contribution room.

Again, it’s complicated. Exempt contributions are usually limited to the Fair Market Value (FMV) of the transferring TFSA at the time of death. Any TFSA growth after death would require new TFSA contribution room. Within 30 days of the contribution, you need to send the Canada Revenue Agency Form RC240, Designation of an Exempt Contribution Tax-free Savings Account (TFSA).

• Retirement tax tips »

To illustrate the complexity involved when you did NOT specify a Successor Holder before death, consider this example from the Mackenzie brochure. Jessie dies with a $60,000 TFSA and his wife Jenny was not a Successor Holder, but was beneficiary of the estate, so inherited the TFSA via Jessie’s will. Six months after the death and during the rollover period, Jenny transfers Jessie’s TFSA to her own TFSA. Her contribution room at the time of transfer was just $10,000; even so, Jessie’s account (which has grown to $62,000 by the transfer time) is fully contributed to Jenny’s account. The first $60,000 was considered an exempt contribution (which doesn’t require TFSA contribution room) while the remaining $2,000 is absorbed by Jenny’s available contribution room. Jenny submitted Form RC240 within 30 days of transfer to ensure that her exempt contribution does not affect her TFSA contribution limit.

Only a spouse can be a “survivor” of a TFSA, Cardy says, meaning only they can make an exempt contribution. There are no special rules permitting a beneficiary (other than spouse or common law partner) to contribute funds from the deceased’s TFSA to their own TFSA. So, for example, where someone names their adult child as beneficiary, the TFSA is collapsed at death and amounts transferred to that child’s non-registered account.

TFSA assets can be transferred to these beneficiaries tax-free (for amounts up to the date of death) but TFSA contribution room is needed to shelter future income from tax.

Remember that in the absence of a Successor Holder, income earned in a TFSA is subject to tax, normally by the recipient of the TFSA, and regardless of whether or not a spouse or common law partner is a beneficiary. So to continue the earlier example, while Jenny’s contribution room let her contribute the $2,000 earned after Jessie’s death to her TFSA, this amount is taxable to Jessie: that is, the $2,000 is fully included in her income for the year of the transfer.

It’s worth knowing that transfer of assets at death is under provincial or territorial (rather than federal) jurisdiction. Except for Quebec, all provinces and territories have updated their laws to allow for beneficiary designations on TFSA applications. In Quebec, TFSA transfers at death pass through the deceased’s estate and are governed by the will.

Jonathan Chevreau is founder of the Financial Independence Hub and co-author of Victory Lap Retirement. He can be reached at [email protected]

Read more of Jon’s column, ‘Retired Money’ »

About Jonathan Chevreau

As MoneySense’s Investing-Editor-at-Large, he is also author of Findependence Day and co-author of Victory Lap Retirement. Reach him at [email protected], where he is the founder of Financial Independence Hub.

Linkedin Twitter Facebook Website