When a TFSA account holder dies, the tax implications may vary depending on who is named as beneficiary, the type of TFSA, if the value of the account increases after death, and how long it takes to distribute the assets. In all cases, the fair market value (FMV) of the account at death can be distributed tax free, however, any gains after death may be subject to tax.

Types of Beneficiaries

There are two types of beneficiaries: The successor holder and the designated beneficiary. The successor holder can only be the spouse or common-law partner (CL). The designated beneficiary is anyone else but can include the spouse or common-law partner.  Whenever possible the spouse/CL should be named as the successor holder. By doing so, upon death the account immediately transfers to the spouse/CL (as is) even if they don’t have sufficient contribution room, in addition, all amounts earned after death remain tax free.

If the spouse or common-law partner is named as the designated beneficiary things become more complicated. Upon death, the spouse/CL can still transfer the TFSA to their own TFSA as an exempt contribution, regardless of their allowable contribution room. However, the transfer must be completed by December 31^st of the following year after the account holder’s death. In addition, any increase in value of the account during the period between the account holder’s death and the time of the transfer will be taxable to the spouse/CL.

Three Types of TFSAs

Deposit – an interest-bearing account or term deposit

Annuity Contract – Segregated fund held at an insurance company

Arrangement in Trust – Mutual funds or brokerage accounts

With all three types of TFSAs, the FMV at death is tax free. There are however slight differences in the treatment of the beneficiaries. For deposit and annuity TFSAs the account is no longer considered a TFSA once the owner dies. The FMV of the account at the time of death will be paid to the beneficiary tax free. However, any capital gains or income earned during the roll over period will be taxable to the beneficiary.

Arrangements in trust, continue to be treated like a TFSA during the exempt period. The exempt period is the time between the account holder’s death and the time the account is transferred to the beneficiary, or until December 31 the year following the account holder’s death, whichever earlier. If the exempt period ends and the TFSA has not been transferred to the beneficiary, the increase in value after death becomes taxable to the trust itself. At that point the trust will be required to file a Trust Income Tax and Information Return and prepare T3s for any distributions of taxable amounts to beneficiaries.

TFSA account holders should review the type of TFSA they hold, and double check their beneficiary designations to ensure they are accurate, updated and align with their estate plan. If you are an Executor, be sure to distribute TFSA assets in a timely manner to avoid any unnecessary tax reporting.

I hope you found this information helpful.

Have a great week,

Tracey

Source: Original article by Curtis Davis FCSI, RRC, CFP, senior consultant for tax, retirement and estate planning services, retail markets at Manulife Investment management. Posted on Advisor’s Edge 05-09-22

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