Check documentation when topping up your TFSA

The Tax Free Savings Account survived its first year.  The rules with respect to the annual TFSA limit after 2009 is that it will be indexed to inflation, while additions to contribution room will be rounded to the nearest $500.  For 2010, the TFSA additional contribution limit will remain at $5,000.

Studies have shown that the majority of people did not open a TFSA in 2009.  As many people still have debt, or other obligations, the TFSA was obviously not the top priority.  Based on the phone calls we received last year, some people felt that they needed to open an account up in 2009 to actually get the $5,000 contribution room.  That is not the case; if you are among the majority who did not contribute at all in 2009 then your eligible TFSA contribution room for 2010 is now $10,000.

We are seeing many situations where people do not have the documentation completed correctly with respect to their TFSA.  Two areas in particular stand out as incomplete:  naming beneficiaries and successor annuitant/holder.

Some tips:

■ TFSA Beneficiary

If you opened your account in early 2009 it was not possible to name a beneficiary on your TFSA.  Legislation has now been passed in British Columbia, but this was done after many had already opened their TFSA.  Advice given at that time was to update their wills to include the assets within the TFSA.  Most people likely felt the $5,000 was immaterial to their estates when compared to the costs and time associated with getting their will updated.

The benefit of naming a beneficiary is the ability for the assets to bypass the estate of the deceased and transfer directly to named beneficiaries.  If no beneficiary is named then the TFSA will be part of the deceased’s estate.  Assets flowing through your estate are typically subject to probate and other fees.

For our clients who opened a TFSA in the initial stages, we sent the beneficiary forms later.  Updating, or changing, your beneficiary should not cost anything.  We recommend you check your original TFSA forms to ensure a beneficiary has been named.  The form is easy to complete and will simplify the asset distribution of your estate.

■ Beneficiary is Not Spouse

If the beneficiary of your TFSA is not a spouse then the assets of the TFSA will transfer to your named beneficiary with no tax consequences to your estate.  If the beneficiary wishes to keep the assets as they were, then an in-kind transfer should be requested.  If the beneficiary wishes to have cash, then instructions to that effect should be provided.  The beneficiary has the option to transfer the assets into their own TFSA, provided that contribution room exists.  If no room exists then the assets can be transferred to a non-registered investment account.

■ Beneficiary is Spouse

There are some distinct differences to naming a spouse as your TFSA beneficiary versus another family member. We recommend most couples name their spouse as a beneficiary.  In addition to naming your spouse as a beneficiary we recommend setting up your spouse as a successor annuitant.

■ Successor Annuitant

For couples, understanding the term successor annuitant is essential.   This is a separate part of the TFSA form, or it could be another form altogether.  A spouse who is named as a successor annuitant is able to roll their spouses TFSA into their own TFSA without using up their own contribution limit.  The plan continues exactly as is with the rights being passed onto the successor.  All income will continue to be tax sheltered after the TFSA holder’s death.

An example:  Mr. Newman has a TFSA and has named his spouse as the beneficiary and a successor annuitant.    At the time of Mr. Newman’s death, his TFSA was valued at $42,000.   Mrs. Newman’s TFSA was valued at $39,500 prior to her husband’s death.  We estimate Mrs. Newman will have a combined $81,500 in her TFSA that is completely tax sheltered.

By naming your spouse as a successor holder it also ensures that income earned after the original holder’s death is not taxed.  If the successor holder is not named then legislation requires taxation of income earned in the TFSA after death.

Just to give you an idea of how new the TSFA account is, some holders have already passed away without having the proper documents completed.  We recommend spouses in this situation speak with their accountant to complete the required CRA form (RC240) to ensure that the TFSA rollover would be treated as an exempt contribution.

As you are depositing top-up contribution for 2010, or setting up a new account, you should ensure that the beneficiary is set up correctly.  If you are married, and naming your spouse as the beneficiary, you should ensure that the successor annuitant form is also completed.

TFSA: HOW IT WORKS

  • Canadian residents age 18 or older can contribute up to $5,000 annually to a TFSA
  • Investment income earned in a TFSA is tax-free.
  • Withdrawals from a TFSA are tax-free.
  • Unused TFSA contribution room is carried forward and accumulates in future years.
  • Full amount of withdrawals can be put back into the TFSA in future years.
  • Choose a range of investment options such as mutual funds, GICs and bonds.
  • Contributions are not tax-deductible.
  • Neither income earned within a TFSA nor withdrawals from it affect eligibility for federal income-tested benefits and credits, such as Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit.
  • Funds can be given to a spouse or common-law partner for them to invest in their TFSA.
  • TFSA assets can generally be transferred to a spouse or common-law partner upon death.

Source: Government of Canada