TaxMatters@EY - July 2014
What happens on the death of a TFSA holder?
Bob Neale and Teresa Gombita, Toronto
Since its introduction in 2009, the tax-free savings account (TFSA) has become an investment vehicle of choice for over 8 million Canadians. The Department of Finance estimated that at the end of 2011, the value of assets in TFSAs was in excess of $62 billion. Individuals, who since 2009 have made the maximum annual contributions and have not withdrawn any funds, will have $31,000 plus accumulated income in their respective plans.
When a TFSA holder dies, what happens to the funds in the account depends on whether the holder identified who the funds should be given to after his or her death and the relationship of that individual to the deceased immediately before death.
A TFSA holder may:
- Name a successor holder for the account, who essentially stands in the shoes of the deceased and becomes the account holder
- Designate a beneficiary for the account — the account will cease to exist and the funds will be distributed to the beneficiary
- Have the account form part of their estate — the TFSA will be distributed according to the terms of the deceased’s will
A TFSA holder may only appoint his or her survivor (i.e., the holder’s spouse or common-law partner at the time of death) as the successor holder for the account. Typically this designation is made within the TFSA plan document; however, it may also be made by will, provided the will states the successor holder unconditionally acquires all of the deceased holder’s rights under the plan including the unconditional right to revoke any beneficiary designation.
The effect of appointing a successor holder is to give continuity to the TFSA. The survivor automatically becomes the holder of the account at the time of the former holder’s death, meaning that the TFSA does not come to an end at the moment of death.
Income tax considerations
From an income tax perspective, there has been no change: any income earned after the death of the holder will continue to accrue on a tax-free basis in the TFSA and the deceased’s spouse or common-law partner may make withdrawals from the TFSA free from tax.
As the successor holder has taken over the TFSA, the normal rules regarding contribution room and the combining or consolidating of TFSA accounts will apply. Where the successor holder had their own TFSA, they may choose to consolidate the two plans by the direct transfer of all or part of the assets of the holder’s plan to their own plan. In most cases, the direct transfer will not affect the successor holder’s TFSA contribution room.
Going forward, the successor holder may make additional contributions to the combined TFSA (or separate TFSAs) based only on their own unused contribution room,
Excess TFSA amount
Usually, the survivor’s contribution room is unaffected by the acquisition of the deceased’s TFSA. However, if the deceased had an excess TFSA amount at the time of death, the excess TFSA amount may pass to the survivor. The survivor will be deemed to contribute the entire excess TFSA amount to a TFSA the survivor held at the beginning of the month after the date of death.
Where there is no successor holder, the TFSA contract may provide for a designated beneficiary or beneficiaries (for example, survivors not named as successor holders, former spouses/common-law partners or children). The person so designated by the TFSA is deemed to have acquired their interest in the TFSA at the time of death for a cost amount equal to its fair market value at that time.
In the event the designated beneficiary is a minor child at the time of the holder’s death, a trustee or guardian must be appointed to receive the proceeds from the TFSA.
Income tax implications
In essence, the fair value at the date of death may be viewed as a non-taxable capital receipt to the designated beneficiary and may be withdrawn free of tax. Any accretion in value after death will be subject to tax in the hands of the designated beneficiary.
There are no special rules permitting a beneficiary (other than a surviving spouse or common-law partner) to contribute funds from the holder’s TFSA to their own TFSA, but the funds received can be contributed as long as they have unused TFSA contribution room available.
Where the designated beneficiary is a surviving spouse or common-law partner, subject to certain restrictions, the individual may contribute all or a portion of the funds received from the holder’s TFSA to their own TFSA as an exempt contribution without affecting their own unused contribution room. It should be noted that this exempt contribution rule is more restrictive than the rule applicable to successor holders.
In order to do this, the exempt contribution payment must be made before the end of the calendar year following the year of death, the payment may not exceed the fair value of the holder’s TFSA at the date of death and the prescribed designation election form must be filed within 30 days after the contribution is made. Where the balance in the TFSA exceeds the fair value at the date of death, the income earned is a taxable receipt.
Asset of the deceased’s estate
Where the TFSA contract does not name a successor holder or designated beneficiary, the property in the TFSA is an asset of the estate and is distributed in accordance with the terms of the deceased’s will.
Income tax implications
Income and accrued capital gains in the TFSA to the date of death are exempt from income tax. The assets of the TFSA form part of the capital of deceased’s estate and may be distributed to the beneficiaries in accordance with the terms of the will.
Income accruing after the date of death, including capital gains or losses, is included in the taxable income of the estate and subject to income tax either in the estate return or the hands of the beneficiaries.
Your next steps
As a starting point, review your TFSA plan documents to determine whether you have appointed your spouse or common-law partner as a “successor account holder” or designated a beneficiary. You may need to speak to your TFSA administrator to confirm this. If your plan was set up in 2009, you may not have appointed a successor account holder.
Decide who you wish to receive the assets in your TFSA following your death. This of course is not a one-time decision, but rather a matter for reflection each time you review your will and estate plan.
Where you decide to leave the TFSA to your spouse or common-law partner, complete the necessary documents to appoint a successor account holder. By doing so, your legacy may continue to grow tax free.