Wealth Strategies: TFSA Tax Planning
Milestone Wealth Management Ltd. - Nov 09, 2022
The TFSA is a relatively new tax-sheltered vehicle, and as such, many Canadians may be confused on the rules surrounding its use. One frequent area of confusion is the tax implications for a TFSA when the account holder passes away.
Tax implications for a TFSA will vary based on the beneficiary, the amount of income earned after death, and the timeframe in which the proceeds are distributed. This differs from an RSP or RIF in that, with a TFSA, proceeds are distributed on a tax-free basis, based on the fair market value (FMV) of the account at death, but any increase to FMV after death is taxable.
TFSA’s also have two categories of beneficiaries, though this is often not known to the beneficiaries until the death of the TFSA holder.
The proceeds of a deceased person’s TFSA can be passed down to either a “successor holder” or “designated beneficiary”. Only a spouse or common-law partner may be named as a “successor holder”, while the “designated beneficiary” category can be used either for a spouse/common-law partner, or anyone else the TFSA holder would like to name. Either category can be set out in a Will or documented on the TFSA directly.
In most cases, the TFSA holder will want to name their spouse as “successor holder”, meaning that the proceeds of the TFSA will immediately pass to the surviving spouse upon the holder’s passing. This is not contingent on the successor holder’s TFSA contribution room, and all amounts earned after the transfer remain tax-free.
A tax complication arises, however, when the spouse isn’t named as successor holder, but rather as a designated beneficiary. As a designated beneficiary, one can transfer the FMV (at death) of the deceased’s TFSA to their own TFSA as an exempt contribution (again, contribution room is not a factor here), provided that they do so by Dec 31st of the year following the holder’s death. Leading up to this transfer, however, any increase in FMV is taxable to the spouse.
One’s choice of beneficiary category could therefore pose a potential tax issue, depending on the nature of the investments within the TFSA, market movements after the holder’s passing, etc.
This is an often-overlooked detail that should be addressed as part of one’s overall estate planning process, with the help of your trusted financial professional(s).