TFSA beneficiary rules: Should you use the successor holder or beneficiary designation?
True or false? When planning to leave your Tax-Free Savings Account (TFSA) to your spouse, it is always best from an estate planning perspective to name your spouse as ‘beneficiary.’ False. This may not be the best strategy. And here’s why.
When naming your spouse to inherit your TFSA account, you have two designation options: 1) you can name your spouse or common-law partner as a successor holder; or 2) you can name your spouse or common-law partner as a beneficiary. Although TFSAs are federally regulated, they’re subject to provincial legislation regarding the transfer after death. Most provinces, including Ontario, now allow for both successor holder and beneficiary designations. Let’s look at the implications of both.
If a TFSA holder names their spouse or common-law partner as the successor holder, then on the death of the TFSA holder, the spouse essentially becomes the new holder and the tax-exempt status of the TFSA is maintained. All of this is done without affecting the TFSA contribution room of the spouse. It is clean, simple, and seamless.
The Income Tax Act only allows the tax-exempt status of the TFSA to be passed on to a spouse or common-law partner who is a successor holder; this is different from a beneficiary. The successor holder can maintain two separate TFSA accounts afterwards, or, better yet, consolidate the deceased spouse or common-law partner’s TFSA with their own. The latter may be easier from an administration and investment management viewpoint.
Regardless, naming your spouse or common-law partner as successor holder will mean that you also avoid probate fees since these assets will pass outside your estate and directly to your spouse or common-law partner.
Now let’s contrast this with naming your spouse or common-law partner as a beneficiary. Things get a little more complicated in this case. Assets still pass outside your estate to your spouse or common-law partner on a tax-exempt basis, but things aren’t quite as straightforward and there are definitely some nuances to consider.
A spouse or common-law partner can transfer assets from their deceased spouse’s TFSA to their own TFSA, as long as this occurs during the ‘rollover period’. This period begins the day of death and ends on December 31st of the following year. Transfers during this rollover period may be deemed to be ‘exempt contributions’ and as such do not affect your TFSA contribution room.
It is worth noting that exempt contributions cannot exceed the fair market value of the deceased’s TFSA at the date of death; therefore, any TFSA growth after the date of death will be taxable. On that basis, it is best to make this transfer as quickly as possible to mitigate taxes.
To declare an exempt contribution, you will need to send the CRA (Canada Revenue Agency) form RC240, Designation of an Exempt Contribution Tax-free Savings Account (TFSA) within 30 days of the contribution to ensure that the contribution from your deceased spouse’s TFSA does not affect your own TFSA contribution room.
The chart below highlights some key points regarding each beneficiary designation type:
TFSA beneficiary designations
|-Only spouses or common-law partners can be successor holders.||-Anyone can be designated as a beneficiary, including a spouse or common-law partner.|
|-Seamless transition – tax-exempt to spouse or common-law partner.||-Tax-exempt status of the deceased’s TFSA is maintained until death. Any investment growth after death will be taxed in the hands of the beneficiary.|
|-No additional paperwork.||-For spouses and common-law partners, funds must be contributed during a ‘rollover period’ – by December 31st of the year following the death of the TFSA holder to be considered ‘tax exempt.’ Investment growth during this time is taxable.
-Tax-exempt contribution form RC240, Designation of an Exempt Contribution Tax-Free Savings Account (TFSA) must be filled out within 30 days of a spouse or common-law partner’s contribution.
|-TFSA contribution limit of spouse or common-law partner is not affected.||-TFSA contribution limit of spouse or common-law partner will not be affected IF tax-exempt contribution form has been filed.|
|-Funds pass outside of the estate and therefore probate fees are avoided.||– Funds pass outside of the estate and therefore probate fees are avoided.|
|-Surviving spouse or common-law partner can maintain separate TFSA or consolidate TFSA accounts.||-Funds can be transferred to a spouse or common-law partner’s TFSA.
-For all other beneficiaries (non-spousal), the account is no longer a TFSA after death. However, funds received up until date of death are tax-free. Funds can be contributed to the beneficiary’s TFSA to the extent that there is TFSA contribution room.
Back to our original question at the outset – what is the best strategy when it comes to selecting your spouse to inherit your TFSA assets? Answer: Consider designating your spouse as successor holder along with a backup beneficiary or beneficiaries, to the extent that this is provincially possible (see sample successor holder / beneficiary designation form below). That way, not only are you providing for a seamless transition of your TFSA assets at death for your spouse, but in the unfortunate event that you both happen to die at the same time, your non-spouse beneficiary or beneficiaries will receive the funds outside of your estate, saving probate fees and time.
If you’re like most people, you may not remember whether you designated a beneficiary or successor holder when you set up your TFSA originally, especially if you opened your account back when they were introduced in 2009 or prior to your province of residence allowing the appointment of beneficiaries or successor holders.
There’s no harm in double checking with your adviser or financial institution and making any needed changes. And for those of you just getting started, now you know the difference between the two appointments. If you’ve never invested in a TFSA before, you could have up to $52,000 of TFSA contribution room in 2017 (if you were over the age of 18 in 2009). Happy investing!