Since their introduction in 2009, tax-free savings accounts have been recognized as a great way to save for any financial goal since no taxes are incurred on income or capital gains by the investments inside the plan, and no taxes are payable on TFSA withdrawals. As well, you may re-contribute your withdrawal in the following year as long as certain conditions are met.
At the same time, there are lesser known, yet equally important, tax considerations for TFSAs. One important issue is what happens to your account when you die. In particular, who receives the assets from your TFSA and how those assets are passed on can have a significant impact on taxes.
As with most assets, it's prudent for many reasons to plan for how the assets in your TFSA will be distributed when you die. By appointing a successor holder or designated beneficiaries for your TFSA, not only can you make certain your wishes are fulfilled, you also ensure that those assets go directly to the chosen individuals, bypassing the estate and potential probate costs.
There are different ways to bequeath your TFSA assets. For couples, appointing one's spouse -- including a common-law partner -- as successor holder of the account is a tax-efficient strategy since it allows the survivor to become the new owner of the TFSA when the original holder dies. But this is a restricted option since only a spouse or common-law partner may be designated as a successor holder. (The successor holder designation is allowed in all provinces except Quebec.)
With a successor holder in place, the TFSA continues as a separate account with its tax-exempt status intact after the original account holder dies. Even better, the new holder's own TFSA contribution room is unaffected by ownership of the inherited account. However, if and when the successor holder makes new contributions to the inherited account, these amounts now count toward their own TFSA contribution room.
If a spouse is not appointed successor holder and is instead designated the beneficiary of a TFSA, they have the option of contributing all or part of the inherited TFSA property -- technically known as a "survivor payment" -- to their own TFSA without affecting their own unused TFSA contribution room.
The conditions are that the amount of this "exempt contribution" can't be more than the value of the TFSA on the date of death, the rollover must be made by Dec. 31 of the year following the year in which the TFSA holder died, and the appropriate Canada Revenue Agency form must be completed and filed with CRA within 30 days of making the contribution.
Unlike the exempt contributions allowed to spouses, the ability of a beneficiary who is not a spouse to direct part or all of a TFSA inheritance to their own TFSA depends on having contribution room available.
Also, if the fair market value of the TFSA assets increases after the date of death to the time the assets are paid out -- say, from capital gains in a rising market or due to interest or dividend income earned by the holdings -- the additional amounts are taxable. The non-spousal beneficiary would be liable for this tax in the year the assets are received. Furthermore, even if the gains come from a tax-preferred source, such as dividends or capital gains, the amount is nonetheless taxed as ordinary income.
