Although minor, the ability to tack a beneficiary designation onto tax free savings accounts is one of those small bits of advice that can differentiate an advisor from the herd.
While most Canadians understand and appreciate the tax-free feature of the TFSA, a survey by Mackenzie Financial shows few are clear about the implications of death on this new plan.
The survey conducted by Leger Marketing, which reached out to 1,500 Canadians, found that among the one in five Canadians who currently hold a TFSA, 48% weren’t sure whether the account would be taxable to beneficiaries on death, and 69% didn’t know if the beneficiary would require TFSA contribution room to continue tax-free growth.
It’s important that clients are aware of the answers to these questions, says Wilmot George, director of tax and estate planning at Mackenzie Financial.
“These results suggest Canadians are setting up TFSA accounts without a complete understanding of the estate planning implications,” George says. “TFSAs are generally passed to beneficiaries tax free. To continue tax-free growth after death, contribution room would normally be required unless a spouse or common-law partner receives the asset.”
Beneficiary designation a good idea
Generally, if a client is using the TFSA as a long-term investment it’s a good idea to name a beneficiary where permitted, particularly in provinces that have probate taxes. In provinces that permit it, a recognized beneficiary designation will allow money to bypass the estate and be paid directly to a beneficiary without probate taxes (if applicable), says Jamie Golombek, managing director of tax and estate planning for CIBC Private Wealth Management.
“Beneficiary designations are only available on certain types of products such as RRSP, RRIF or a life insurance policy,” Golombek says. “The money in the RRSP or the RRIF goes directly to the beneficiary upon death and bypasses the estate. The primary winners here are clients in provinces such as Ontario and B.C., which have high probate taxes.”
However, not every province allows clients to name a beneficiary on their TFSA. While all Canadians can pass the TFSA on to their beneficiary tax-free, only in some provinces will that money pass without being subject to a probate tax.
“Unless the province or territory amends its own specific legislation to allow a beneficiary on a TFSA, even though the amount will be income-tax free upon death, it might still have to go through the estate, so that in a province like Ontario, absent a beneficiary designation, you’ll have to pay 1.5% probate tax when you die,” Golombek says.
So far four provinces and one territory have enacted beneficiary designation legislation for TFSA:
- British Columbia;
- Nova Scotia;
- Prince Edward Island; and
- Northwest Territories.
The 2009 Ontario budget also promised to introduce legislation in Ontario to allow beneficiary designations. The Yukon has already introduced draft legislation.
Golombek says there’s no huge monetary benefit to having the beneficiary designation this year. The difference in Ontario, if someone were to die in 2009, is 1.5% tax or $75 on the current TFSA limit of $5,000 per year, per person, assuming there’s no growth on the account.
While it’s a small sum, clients are likely to appreciate that advice. Like everything else with the TFSA, the more contribution room it gains over time, the more powerful the compounding rate of minimizing taxes will be.
“We tell people they should be maximizing their TFSA contributions every year. The limit is $5,000 per person, per year. Hopefully everyone has already contributed the $5,000 for 2009,” Golombek says. “[Probate taxes] are not a big deal right now. As these accounts grow and people start to invest more money in TFSAs, the accounts will go up in value. When these accounts are worth $100,000 or $200,000 then you might be looking at some substantial savings.”
Canadians risk adverse, short-sighted
While many Canadians may recognize the power of the tax-free nature of TFSAs, they are not maximizing their growth potential. When TFSA-holders were asked how they’d use their account, the most common answer (36%) was to leave it alone for the long-term to use for things such as retirement, or children’s education. They didn’t choose high-growth investment vehicles.
When TFSA holders were asked about the type of investments a majority of their money was invested in, 51% said short-term vehicles such as cash, short-term GICs, or money market mutual funds.
Granted, these products offer minimal downside risk, but clients should also be aware the tax savings on the interest these would generate on $5,000 are probably less than $100. The growth potential on equities at this point in time and the amount that would be saved in potential capital gains is far greater.
“If your goal is to save long-term for retirement, then a short-term vehicle might not be the most suitable,” George says.