Inheriting a TFSA is very complicated

Inheriting a TFSA is very complicated

UPDATE DAY

On death, how is the transfer of a TFSA to the surviving spouse? To summarize, allow me to quote my late grandmother Marchand: “It's a cursed aria! “

I hadn't realized how delicate this operation could be. before receiving Julie's email. 

Our reader conducted her investigation before writing to us. His research got bogged down due to lingering ambiguities surrounding the issue.

What's so complicated? 

Quebec and Canada 

First, let's tackle the source of the confusion: it's not the same in Quebec as in the rest of Canada. Elsewhere in the country, the holder of a Tax-Free Savings Account (TFSA) can name a “successor holder”, which means that the account can be transferred to the spouse without friction after death.  

The law in Quebec does not allow this, except in a specific case (through an annuity contract), but the paperwork of Canadian banks does not seem to take this distinction into account. It therefore leaves floating the possibility of filling out a form to designate a beneficiary. The information also did not reach all the personnel of the Canada Revenue Agency, at least that is what I deduce from Lucie's account. 

There is another way to ensure the transfer of the TFSA to the surviving spouse, the only one accessible to Quebecers: the testamentary bequest. As in: “ Me Marcel, I bequeath my TFSA to my spouse Francine. ”

It looks simple, too, but it's in your best interest to act quickly after death, because it can cost you a lot of tax. 

The TFSA on death

As we know, TFSA returns are not taxable, whether during the lifetime or upon the death of the holder. However, after death, and until the contents of the account are rolled over to the TFSA of the surviving spouse, the gains made in the meantime are no longer sheltered from the tax authorities. 

“In addition, the returns then lose their nature. Whether it’s capital gains or dividends, they will be treated as 100% taxable income,” explains Natalie Hotte, senior tax, retirement and estate advisor at National Bank Trust. Remember that half of capital gains are taxable while dividend income benefits from tax relief. 

A minor problem, do you think? 

By an example, the tax specialist demonstrates how the situation can be unfair. In January 2020, a client held $84,000 in his TFSA. Then came the pandemic and the stock market crash. The account's value plummets to $65,000, its holder dies soon after (the story does not say whether the COVID-19 pandemic or the falling markets are to blame).

Before the close, the TFSA bounced back to $80,000. Result: The Canada Revenue Agency issued a T4a slip for $15,000.  

Close the TFSA as soon as possible

The content of the TFSA at the time of death corresponds to the amount that the surviving spouse can use as an “excluded contribution”. to his own TFSA. By “excluded” we mean that it does not reduce the contribution room of the heir to the account. The money will pass from the account of the deceased to that of the estate before ending up in that of the recipient. This is how rolling happens.

To reduce the tax impact, there is only one way: close the TFSA as quickly as possible and move the securities to the estate account. If not eliminating the tax, this operation at least allows the capital gains to be taxed as such.

Another option: liquidate the securities inside the TFSA upon death, close the account, transfer the money and redeem the same (or other) securities in the estate's account. 

For someone unfamiliar with such maneuvers (including me ), it can cause sweating. Without support or advice, it is intimidating. Interest groups, including financial institutions, are urging Ottawa to eliminate these pitfalls. 

When the TFSA is intended for the surviving spouse, this heaviness does not have to be. Neither does the resulting tax bill.

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