In 2009 the federal government introduced the Tax Free Savings Account concept to Canadians. For anyone 18 years or older the TFSA has been whole-heartedly embraced as a tax-efficient vehicle to save money for short and long-term needs.
However, many people do not fully understand the importance of proper beneficiary designations and subsequently, they miss additional tax planning opportunities.
Named Beneficiary vs. Successor Holder/Owner
Naming a spouse as Successor Holder/Owner means they now own the deceased spouse’s TFSA upon death. This designation is important because if each spouse has maximized their lifetime contribution of $81,500, the surviving spouse would now have a total of $163,000 in their TFSA, which is double the current maximum limit.
If the spouse had been appointed the Primary Beneficiary, the deceased’s TFSA would be closed and the $81,500 paid out tax free to the surviving spouse. This pay out could not be transferred seamlessly to a TFSA, as it would exceed the lifetime limit. Note: CRA does provide a small window for the surviving spouse to make an exempt rollover, but it entails “less than user friendly” tax compliant forms.
General Rule of Thumb – for couples in a stable long-term relationship it is better to appoint each other as Successor Holder/Owner than as a Primary Beneficiary.
What if I do not have a spouse or if I prefer someone else to receive the proceeds?
Any adult can be appointed the Primary Beneficiary, including, children, relatives, a close friend, or a favourite charity/nonprofit society.
One advantage of having your TFSA with a Canadian life insurance company is that a Contingent Beneficiary can be appointed. This means if the Primary Beneficiary passed away before the owner of the TFSA, the proceeds would be paid to a secondary beneficiary.
This designation opportunity is especially valuable for blended families, where the current spouse is appointed Successor Holder/Owner and the children from the first marriage are named as secondary beneficiaries.
What happens if my child is still a minor?
The proceeds can flow through tax free to the minor child, but a designation should be made that the funds would be “In Trust For.” This is referred to as an informal Trust and is quite simple to set up. It is extremely important to appoint a Trustee to manage the money until the child is of legal age.
Another advantage of establishing an, In Trust For account (ITF), is that the child declares any Capital Gains, and since most children have very little income to declare, almost all the growth would remain tax free.
Beware of setting up GICs in an ITF account as CRA demands that passive income like interest on a GIC revert to the Trustee. I recommend a pure equity fund composed of both Canadian and American blue-chip stocks.
Should the “Estate” be appointed as beneficiary?
The problem of having funds flow through to the Estate is that Probate Fees are then applicable, and this can easily be 1.5% to 2.5% in unnecessary taxes. Having a named beneficiary or a Successor Holder/Owner avoids this fee.
It is appropriate to name the estate as Beneficiary, when the funds will be transferred to a formal Trust established by the executor. If the deceased’s Will states that net assets and proceeds (after income taxes and other debts are settled) are to fund a Testamentary Trust, then the primary beneficiary must be the estate.
What if my adult beneficiary is a “spendthrift” and I am concerned about leaving them a large lump sum?
Another advantage of having a Canadian life insurance company hold the TFSA is that a Settlement Option can be attached to the primary beneficiary designation. This means that the death proceeds are not payable as a hefty sum, but instead paid out monthly/annually as a form of annuity.
This is a brilliant way to ensure a child who may have substance abuse, gambling or poor money management issues will not squander the proceeds.
Whereas a Testamentary Trust has more advantages in protecting the long-term best interests of beneficiaries; there is a cost to setting up and maintaining a formal Trust. Using a Settlement Option to purchase a predictable stream of income in the form of an annuity, costs nothing and is desirable when dealing with modest inheritances.