François Bernier, notary and director, advanced planning with Sun Life Financial, looks at a topic that’s getting people talking.
Think you know all there is to know about the Tax-Free Savings Account (TFSA)? You might be surprised. The process of transferring TFSA proceeds on the account owner’s death isn’t always clearly understood.
A hefty TFSA could pack a big tax punch
An investor who has never contributed to a TFSA can deposit $52,000 in 2017.1 “Since the growth is tax-sheltered, some investors could eventually end up with an account containing more than $100,000,” says Bernier. And that’s why we’re now starting to see this topic in the news more often, as a sizable TFSA can have a substantial financial impact at death.
The basics: a quick review
When the owner of a TFSA dies, the money in the TFSA becomes accessible to the owner’s estate, with no tax impact, if no successor holder or beneficiaries exist. If the account owner decides to leave the TFSA proceeds to one or more of their children, the amount accumulated up to the date of death will be non-taxable, and the heirs can use it as they wish. However, if the heirs want to transfer the money into their own TFSA, they’ll have to be careful not to exceed their remaining contribution room.
If the deceased owner of a TFSA had named their surviving spouse (married or common law) as the beneficiary to their TFSA, the spouse can take advantage of what is referred to as an “exempt contribution.” This means that the spouse can transfer the current balance in the TFSA — its fair market value, in other words — into their own TFSA, even if all of their available contribution room has already been used. “Subject to completing a form RC240 (Designation of an Exempt Contribution — Tax-Free Savings Account) and filing it within 30 days of applying the contribution to their own TFSA, that is,” Bernier clarifies.2
An example is worth a thousand words
At the time of his death in June 2017, John owned a TFSA that contained a total amount of $52,000. His spouse, Mary, can complete the form in question and add this $52,000 to her own TFSA, even if she has already contributed the maximum she’s allowed.
“However, there could be some capital appreciation between the date of death and the date the funds are transferred. Transfers like this don’t happen in a day. The deadline for completing the rollover to the spouse is December 31 of the year following the year of death,” explains Bernier.
Mary has the option of transferring the fair market value of her deceased husband’s TFSA, which is invested in mutual funds, into her own account before December 31, 2018. Keep in mind, however, that any capital appreciation that happens between those two dates will be taxable. If, for example, there’s a huge upswing in the markets and the TFSA’s value skyrockets to $62,000 during the 18 months in question, the result would be an amount of $10,000 that is taxable to Mary. Any capital appreciation after John’s death is considered interest income, which is subject to taxation and is not included in the rollover to the surviving spouse.
The advantage of segregated fund products
A key advantage of choosing an insurance product for a TFSA is the ability to appoint a beneficiary right in the insurance contract. If the spouse is named beneficiary, a death claim is paid, and the spouse then transfers the money to their own TFSA.3If the spouse is named in the contract as the successor holder, they become the owner of the TFSA. “On John’s death, if the money is invested in a segregated fund product, there would be a direct transfer of the assets to Mary, as the successor holder of the contract. In that case, the tax impact we outlined in the situation above would be eliminated,” says Bernier. Also, as successor holder, the client wouldn’t have to fill out a form RC240.
“Remember, too, that with a beneficiary designation, the money invested in segregated fund products passes outside the estate, meaning that it is paid promptly and directly to the beneficiary appointed in the insurance contract,” he adds.
On the topic of beneficiaries, there is a subtle difference for clients in Quebec. In Canada, regardless of which institution issues the TFSA, clients can designate their spouse (married or common law) as the successor holder of the plan or beneficiary. In Quebec, however, only insurance products, including segregated fund products, allow a successor holder or beneficiary to be named in the contract. Another way of looking at it is that clients can name a beneficiary for non-insurance products across Canada, except in Quebec.
An important note
With segregated fund products, if a spouse is the successor owner of the TFSA, no death benefit is payable, and the death benefit guarantee won’t be available. Sometimes, it’s better to name the spouse as the beneficiary.
A reminder to clients might be helpful. With the increasingly important role that TFSAs are poised to play in retirement income tax planning, the goal, as always, is to eliminate any tax on these plans at the time of the account owner’s death.
The advisor Mary worked with gave her good information. This is a great example of the added value you can offer and take pride in providing.
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1 This statement assumes the investor is eligible for all years, was 18 years or older when the TFSA was purchased, and has been a resident of Canada since 2009.
2 Form RC240 is required when the surviving spouse has been named as the beneficiary (https://www.canada.ca/content/dam/cra-arc/migration/cra-arc/E/pub/tg/rc4466/rc4466-16e.pdf, p. 15). It’s not required if the surviving spouse or common-law partner is the successor holder, and if the deceased holder had no excess TFSA amount in their account at the time of death; that is, they had not over-contributed to their TFSA, or if they had, they had corrected the over-contribution by the date of death. (https://www.canada.ca/content/dam/cra-arc/migration/cra-arc/E/pub/tg/rc4466/rc4466-16e.pdf, p. 13).
3 This type of rollover is, however, available only when the beneficiary qualifies as a spouse.