Feds loosen death rules for TFSA

By Bryan Borzykowski | July 16, 2008 | Last updated on July 16, 2008
3 min read

As excited as advisors got when the tax-free savings account (TFSA) was introduced in the March 2008 federal budget, the legislation wasn’t perfect. Thanks to new amendments made by the Conservative government, however, some of the TFSA’s flaws have been fixed.

One concern advisors and tax experts had in March was related to the laws dealing with the death of a TFSA account holder. Back then, a TFSA would become a taxable trust the day after the person died, meaning any income or gains would be taxable to the trust — the highest marginal tax rate — unless the income is allocated to the trust’s beneficiaries.

The financial industry felt the rules were too strict, and lobbied the government to change the legislation. “It would have been impossible to get the funds out before they’d become taxed,” says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management. “Very often the advisor is not made aware of a client’s death until days, weeks, months or even years afterwards, so the problem was, you’d have someone die and then all of a sudden the account is theoretically taxable.”

On Monday, the government showed that they were listening. Now, TFSAs won’t be taxed until the end of the year after a client passes away. So, if someone opens an account in 2009, it won’t be taxed until January 1, 2011, allowing beneficiaries — who are stated in the will, not on the TFSA account — to withdraw the funds tax free.

However, not every dollar in the TFSA will be tax exempt. If the account accumulates funds after the holder’s death, that money will be taxed. For example, a person dies a month after putting $5,000 into his TFSA; the investment grows to $6,000 over the next year. When the beneficiary pulls out the cash at the end of 2010, she’ll have to pay tax on the extra $1,000, though not on the initial investment. “This is the increase in fair market value,” says Golombek. “It would be taxed to a beneficiary as straight, regular income.”

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  • If the money is not withdrawn after the new deadline, the account will become a taxable trust.

    There are still some questions surrounding death and the TFSA. Sandy Cardy, vice-president of tax and estate planning services at Mackenzie Financial, is unsure whether the new rules mean that the account can avoid probate. So far, the provincial governments, who are responsible for probate, haven’t spoken up on the issues. “Probate is a provincially levied form of tax,” she explains. “This was introduced by the feds, who don’t care about probate.” She says she does think it is possible that the provinces will allow the TFSA to be left probate-free to the next generation.

    If that happens, children of the deceased could benefit immensely. “We can see how this amount in a TFSA over 20 or 30 years could exceed $1 million,” says Cardy. “It could be a big amount of money, so saving probate taxes on that is significant.”

    Another area that needs to be addressed by legislators is how to designate a beneficiary. Golombek says a client can’t name a beneficiary right on the TFSA forms, but Cardy says that’s still up in the air. “We’re not certain whether or not you can name a beneficiary on the TFSA and leave it to a child, even though it would lose its tax-exempt status,” she says.

    But despite a few kinks that still need to be worked out, most people are pleased with the federal government’s amendments. “This is a very positive development,” says Golombek. “It clearly shows the value of conversation between industry and government, and they really listened to what the industry had to say.”

    Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com


    Bryan Borzykowski