When helping your clients set up their tax-free savings accounts (TFSAs), explaining how to designate a beneficiary to avoid any taxable events or unintended consequences following the client’s death is important.
Clients can designate three main types of beneficiaries for their TFSAs: a successor holder; a named beneficiary; or an estate. Unlike the assets held in an RRSP, which may be inherited by the named beneficiary, the various beneficiary designations for a TFSA are subject to different taxation and transfer rules.
“As a starting point, you must consider who you want to receive the funds [when you die],” says Sara Kinnear, director, tax and estate planning, with Investors Group Inc. in Winnipeg.
For most clients, this is a simple decision. However, some clients may not understand the rules governing the various beneficiary designations and, consequently, might unintentionally select a type of beneficiary that’s not the most favourable option, cautions Heather Holjevac, senior wealth advisor with TriDelta Financial Partners Inc. in Oakville, Ont.
For example, a married client could name the estate instead of the spouse as the beneficiary without thinking about the consequences.
“Typically, you will want to name your spouse or common-law partner as successor holder of your TFSA,” says Kinnear, “[as long as the] spouse is mentally capable, not insolvent [and] you want your spouse to inherit the TFSA assets.”
In fact, a TFSA holder cannot name any individual other than his or her spouse or common-law partner as the successor holder. The successor holder can be named in either the TFSA contract or the will of the deceased TFSA holder, provided the will states the successor holder will acquire all of the rights of the deceased under the TFSA unconditionally, including the right to change any beneficiary designations or any other direction imposed by the deceased accountholder relating to the TFSA’s assets.
The advantage of having a successor holder, says Evelyn Jacks, president of the Winnipeg-based Knowledge Bureau, is that he or she assumes ownership of the TFSA as if it were his or her own. The successor holder then can combine the inherited assets with his or her own TFSA or leave the inherited assets in a separate TFSA in his or her name. The contribution room in the successor holder’s original TFSA is not affected.
Any income earned from the inherited assets remains sheltered from taxation. The successor holder can make tax-free withdrawals from the inherited account or make contributions to it, subject to his or her contribution room.
Clients also can name one or more beneficiaries of their TFSAs. When the accountholder passes away, the TFSA is deregistered and the assets are transferred to the beneficiary tax-free. The beneficiary can use the funds to make a contribution to his or her own TFSA, if he or she has the available contribution room.
However, the beneficiary is deemed to have acquired the assets at fair market value at the TFSA holder’s death. Thus, any gains made in the TFSA following the death of the account holder will be taxable in the beneficiary’s hands.
In the event that the TFSA holder names his or her spouse as the beneficiary (as opposed to naming the spouse as the successor holder), the deceased’s TFSA assets can be transferred to the beneficiary’s TFSA account. This must be done before the end of the calendar year following the accountholder’s year of death, says Kinnear.
The beneficiary will have to file a prescribed form with the Canada Revenue Agency within 30 days after the transfer has been made in order to obtain a special exemption. In this case, the transfer of the funds to the beneficiary’s account – if it’s a spouse or common-law partner – will not affect the beneficiary’s TFSA contribution room. However, any gains made in the TFSA following the original accountholder’s death will be taxable.
Holjevac recommends that your clients name a beneficiary, in addition to a successor holder, in case the successor holder dies before the TFSA accountholder.
(Kinnear notes, though, that clients cannot designate a beneficiary in Quebec.)
The TFSA holder also can name a qualified donee or charitable cause as the beneficiary of the assets upon death. The assets must be transferred within 36 months after the accountholder’s death. The deceased’s tax return then can be refiled to claim the charitable donation.
A TFSA holder also can name his or her estate as the beneficiary. The estate also becomes the beneficiary if no successor holder or beneficiary is named in the deceased’s TFSA contract. In such cases, the TFSA assets are distributed in accordance with the terms of the deceased’s will.
However, the TFSA assets then will lose their tax-free status in an estate and be subject to probate fees, which vary by province.
© 2016 Investment Executive. All rights reserved.