Your Tax-Free Savings Account (TFSA): the advantages of designating a beneficiary
Most Canadian investors by now are familiar with the Tax-Free Savings Account (TFSA). Since the TFSA was introduced in 2009, Canadians (age 18+) are able to contribute a limited amount of funds to their TFSA each year. Any investment income earned on those contributions is non-taxable. Additional contribution room is also granted to eligible Canadians at the beginning of each calendar year, which can be carried forward indefinitely if not used.
Any Canadian resident, with a valid SIN and who is 18 years of age or older is eligible to open a TFSA. Non-residents who are 18+ and have a valid SIN are also eligible. However, any contributions made while a non-resident will be subject to a 1% tax for each month the contribution stays in the account. Canadian residents who are residents of another country for tax purposes (e.g., the US) should consult with their advisor prior to opening a TFSA, as it may not be tax-sheltered in that other country.
What you may not be familiar with are the consequences upon death for your TFSA. If you haven’t designated a beneficiary for your TFSA, then, by default, the funds will be directed to your estate, subject to probate fees, and distributed in accordance with the terms of your will. Your estate beneficiaries may then contribute the distributed funds to their own TFSA accounts, only if they have sufficient unused contribution room to do so.
A more tax- and probate-efficient way to transfer funds is for the TFSA account holder to appoint a beneficiary for his or her account. There are two types of designations specific to a TFSA: a successor holder and a designated beneficiary.
Successor holder
A surviving spouse or common-law partner may be designated as the successor holder. With this designation, the TFSA continues to exist after death and is transferred directly to the successor holder. The deceased’s unused contribution room is lost but the successor holder’s unused contribution room is not impacted. The successor holder may choose to make a qualified transfer to their own TFSA if they prefer to consolidate the two accounts. With this arrangement, the TFSA is assumed to be transferred immediately upon death, therefore all income earned in the account after death continues to be non-taxable. Appointing a successor holder ensures that an account holder’s surviving spouse or common-law partner will take possession of the funds without any tax liability incurred.
Designated beneficiary
A surviving spouse or common-law partner, former spouse or common-law partner, or child of a TFSA holder may be appointed as a designated beneficiary. This designation does not allow the TFSA to continue after death – the assets in the TFSA immediately cease to be tax-sheltered and any investment income earned after death is taxable to the beneficiary. The designated beneficiary may then contribute the funds to their own TFSA, provided they have the sufficient unused contribution room.
Exempt contribution
More favourably, if the designated beneficiary is a surviving spouse or common-law partner, they can transfer the funds from the deceased’s account as an exempt contribution. This designation allows for the funds to be contributed to their own TFSA without impacting their unused contribution room, effectively providing the same rights as a successor holder. For an exempt contribution to qualify, it must be made before the end of the calendar year that follows the year of the TFSA holder’s death. The value of the exempt contribution cannot exceed the fair market value of the assets in the TFSA at the date of death. Any investment income earned after the date of death up to the date of the exempt contribution is taxable.
Comparing the two designations
Designating a successor holder is the most tax-efficient succession plan for a TFSA. This arrangement allows the assets to avoid probate fees and remain tax-sheltered in a TFSA throughout the estate transfer process and into the future under the successor holder’s control. Naming a designated beneficiary also protects the funds from probate fees, but is not as tax-efficient as designating a successor holder. If a designated beneficiary is appointed, filing for an exempt contribution is an effective way for the beneficiary to preserve valuable TFSA contribution room.
| Successor holder | Designated beneficiary | |
|---|---|---|
| Who can be appointed? |
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| Is there protection from probate fees? | Yes | Yes |
| What are the tax consequences? | None. The TFSA continues after the deceased’s death and is transferred directly to the successor holder without impacting the successor holder’s unused contribution room. | The account ceases to be “tax-free” on death and any investment income earned is taxable until the funds are contributed to the designated beneficiary’s TFSA. The designated beneficiary may only contribute to their TFSA if they have sufficient contribution room unless they qualify for an exempt contribution. |
About the authors
Jonah Friedman, CPA, CA, is an Associate Director on our Family Office team. He can be reached at 416-645-6518 or jfriedman@fullerllp.com.
Sloan Levett, CPA, CA, CFP, TEP, FEA is the Partner and Practice Leader of our Family Office team. He can be reached at 416-645-6581 or slevett@fullerllp.com.
Cheryl Ng, CPA, is the Associate Director, Investments and Strategic Planning, Family Office. She can be reached at 416-645-6573 or cng@fullerllp.com.