TAX UPFRONT

Unexpected Taxes

TFSA guidance for executors

From its humble beginning in 2009 and that first $5,000 of contribution room, the Tax-Free Savings Account (TFSA) has grown to become an increasingly important component of our savings.Cumulative room in 2022 is $81,500 for those who were at least 18 in 2009, which means investment accumulation could be well into six figures.

And the investment accumulation could be double that for couples who can use the survivor rollover rules on death without affecting the TFSA room of the spouse/common-law partner (CLP). The qualifying rollover amount is the lesser of the TFSA’ s fair market value (FMV) at death and the amount paid to the survivor. It’ s a generous feature, but the “lesser of” constraint can be problematic, in addition to tax leakage when income is earned while awaiting transfer to the survivor.

Though these concerns may be minimal if the transfer happens quickly, they can become costly if the proceeds go through an estate, particularly when there are delays in administration. Fortunately, there are some things an executor can do to limit the harm.

TAXABLE EVENTS

It may seem odd to think of a TFSA as taxable, given its name. But it can happen, either through overcontributions during the holder ’ s life, or following the holder ’ s death. For couples, the easiest solution in the case of death is to designate the spouse/CLP (the survivor) as successor holder, either on the plan or through the holder ’ s will. The TFSA continues to exist in its current form, with the survivor carrying on as its new holder.

The use of a beneficiary designation does not have the same continuity effect, even if the survivor is the beneficiary. Such designation assures that the plan proceeds go to whoever is named, including avoiding probate tax in provinces where that is an issue. But income tax will still apply on earnings after death.

A TFSA may be in the form of a deposit, annuity, or trust. For deposits and annuities, the holder ’ s death causes a disposition of the TFSA at FMV, with any subsequent earnings taxable to a beneficiary(ies) or estate.

TFSA TRUSTS

A TFSA trust continues as a non-taxable trust after the holder ’ s death, until distributed to beneficiaries. Though this sounds like a positive result, any income earned after death is indeed taxable, but generally to the beneficiaries. However, it will be taxed to the trust if the distribution has not occurred by December 31 of the year after the year of death, known as the “ rollover period. ”

As the owner of a TFSA can name a successor holder or beneficiary, one might ask why a TFSA would end up in an estate. Apart from Quebec (where one cannot legally make such designations), the simplest answer is that the holder may not have been aware of this option, or that the named person is pre-deceased.

Alternatively, it may be a conscious intention to allow for the TFSA to fall into the estate to be managed according the terms of the will. This may be a strategic move to provide more flexibility in caring for heirs, possibly driven by mixed family considerations, a late-life marriage, disability issues, spendthrift concerns, charitable planning, or just general liquidity.

Whatever the reason, the executor now has control, so what then can be done — and why?

RISKS AND RESPONSES

With the understanding that the executor ’ s first obligation to the estate is legal in nature, these tax issues offer extra impetus to obtain the official appointment without delay. Within those boundaries, here are some tactics that may then be considered.

For a TFSA that comes into the estate, the continuing growth in the non-taxable trust will eventually be taxed as regular income when distributed to beneficiaries. Accordingly, the executor could close the TFSA and deposit the proceeds to a nonregistered estate account that can take advantage of the preferred treatment of Canadian dividends and capital gains.

The executor could face a dilemma if the TFSA has fallen in value since death, as crystallizing that loss will reduce the eventual exempt contribution available to the survivor, due to that “lesser of” calculation. On the other hand, assuming the TFSA has at least held its value, the exempt contribution will be unaffected, and the move out of the TFSA will protect against a future loss that could reignite this concern.

The additional benefit is if the new account is opened within the first 36 months of a graduated rate estate, low tax bracket rates will be available to use against this income. Still, a sufficient estate distribution would have to be made to allow the spouse/CLP to make an exempt contribution within the rollover period, again being up to December 31 of the year after the year of death.

As noted above, the executor ’ s first duty is to the estate, and in turn its beneficiaries. Of course, the executor and spouse/CLP are often one and the same. Whatever the makeup of the estate, any tax-driven actions should first be discussed with legal counsel.

DOUG CARROLL, JD, LLM (Tax), CFP, TEP, is a tax & estate specialist with Aviso Wealth. He can be reached at doug@douglascarroll.ca.

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