What happens when a TFSA holder dies?

It primarily depends on whether there is a qualified ‘successor holder’ to take ownership of the account

What happens when a TFSA holder dies?

When thinking about estate plans, many people consider what’ll happen to the house, the car, and the wealth in general. But not enough Canadians think about the implications for one major investment vehicle: their TFSA.

“When the owner of a TFSA dies, the tax consequences turn primarily on whether the owner had a surviving spouse or common-law partner who qualified as the TFSA's ‘successor holder,’” wrote David Rotfleisch of Rotfleisch & Samulovitch PC in a recent note.

According to Rotfleisch, an individual becomes the new holder of a TFSA if they were the TFSA holder’s spouse or common-law partner at the time of the holder’s death; were named by the deceased as the successor holder; and acquired all the deceased’s rights under the TFSA, particularly the right to revoke a beneficiary of the TFSA. The successor holder won’t be taxed on the deceased’s TFSA funds or any income earned in the TFSA after the original owner’s death, but they may lose contribution room in their own TFSA if the deceased over-contributed into their TFSA.

Importantly, the deceased holder may name someone aside from their spouse or common-law partner as the TFSA beneficiary, or the spouse or common-law partner may not have gotten the right to revoke a beneficiary under the TFSA of the deceased. In such cases, no one qualifies as the successor holder of the TFSA.

If there is no successor, the account will lose its status as a TFSA after a yearlong grace period starting upon the death of the holder. At that point, the account is deemed to dispose of its holdings for fair market value — thus possibly realizing a taxable capital gain — and treated as an intervivos trust for tax purposes. 

During the grace period, income earned in the deceased’s TFSA remains non-taxable. But a beneficiary receiving proceeds from the account may attract tax liability. Specifically, if the TFSA still exists on Jan. 1st of the year following the end of the exempt period, it will be taxed the same as an intervivos trust, and it must report in its first tax return any undistributed income or gains accrued during the exempt period.

“If a beneficiary receives proceeds from the TFSA, the beneficiary must include in his or her income the amount of any proceeds exceeding the fair market value of the TFSA immediately before the holder's death,” Rotfleisch said. “In contrast, a beneficiary need not report as income a payment from among the TFSA capital or earnings that accrued before the holder's death.”

A non-spouse beneficiary may contribute the proceeds from the deceased’s TFSA into his or her own TFSA only if they still have contribution room. But a spouse beneficiary can make an “exempt contribution” — one that doesn’t affect the room in their TFSA — before the end of the year beginning after the deceased's death; assuming the spouse received the funds as a result of the deceased’s passing and out of the account ceasing to be a TFSA because of the event, they just have to designate the contribution within 30 days, make sure it doesn’t exceed the fair market value of the deceased’s TFSA at the time of death.