Class is far from being dismissed when it comes to learning about tax-free savings accounts.
TFSAs were introduced in the 2008 federal budget and were much publicized in the lead-up to their introduction this past Jan. 1, and thereafter. But the learning process for people using these must-have accounts has just begun.
"The TFSA is a new product and, often with new products, it takes time for the market to digest it and learn all the ins and outs," said Wilmot George, a specialist in tax and estate planning with Mackenzie Financial.
The most recent example is the changing situation regarding the naming of a beneficiary for your TFSA. The province of Ontario recently announced new legislation that brings it in line with most other provinces in simplifying things for beneficiaries.
Another example of the evolving understanding of TFSAs concerns the rules for withdrawing money from a plan. TFSAs are all about saving or investing money tax free - those 18 and older can contribute $5,000 annually - but money may have to come out at some point. We are, after all, in a recession.
On the beneficiary issue, Mr. George explains that while TFSAs are federally regulated, they're subject to provincial legislation covering the transfer of assets after death.
As a general rule, the fair market value of your TFSA can be received by your estate on a tax-free basis, although taxes do apply on any investment gains generated after death. The drawback of allowing your TFSA assets to be made part of your estate is that they would be subject to probate fees or taxes, which in some provinces can mean a hefty financial hit.
Where a spouse or common-law partner is concerned, the smart way to ensure a smooth transition for your TFSA is to name him or her as a successor account holder, which is different from a beneficiary. "In this way, your spouse essentially steps into your shoes as the TFSA owner," said Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce.
Mr. Golombek said taxes don't apply in this situation, and the recipient does not need to have any contribution room in his or her own TFSA to absorb the new money. As well, the recipient's TFSA contribution room is unaffected.
Ontario just joined the majority of provinces that have made it easier to leave TFSAs to beneficiaries like children and other individuals who aren't spouses or partners. In these provinces, a person named as a beneficiary can receive the assets in a TFSA without them passing first through the estate and potentially incurring probate costs.
You can name a spouse as a beneficiary, but it's simpler and cleaner to name them successor account holder.
Beneficiaries who are not spouses or partners can take the funds they receive and put them in their own TFSAs, provided they have the contribution room. If there's limited or zero room, then the excess proceeds essentially become a non-registered account.
Note that a spouse named as a beneficiary could add TFSA assets to his or her existing account without any worries about having the necessary room. This "exempt contribution" must be made by the end of the year following the date of death.
As for taxes, the amount held in the TFSA on the date of death can be transferred tax-free to beneficiaries. However, any gains generated by the account after that date would be subject to taxes. These gains would be taxed according to whether they were interest income, capital gains or dividends.
Can you remember whether you designated a beneficiary or successor account holder when you set up your TFSA late last year or earlier in 2009? If not, go to the financial institution that holds your account or to your financial adviser and check. You can always make changes to an existing account.
Taking money out of a TFSA is another area where it's important to understand the rules before acting. One of the unique features of these accounts is that you can withdraw money and then put it back in again. With registered retirement savings plans, money withdrawn can't be restored later.
However, recontributions can only be made in a future year. So if you removed $2,000 today, you couldn't put it back until the beginning of 2010. At that point, Mr. George notes, your total contribution could top out at $7,000 - $2,000 to pay back what you withdrew, and $5,000 for your 2010 annual contribution.
If you have any discretion about when you'll remove money from a TFSA, do it as late in the year as possible so as to allow for a quick recontribution.
***
Benefits for beneficiaries
Ontario recently joined the list of provinces where money held in a TFSA can bypass the estate of a deceased plan holder and be passed directly to a designated beneficiary. Here's how the
provinces compare:
BENEFICIARY DESIGNATIONS ALLOWED
British Columbia
Alberta
Ontario
New Brunswick
Newfoundland and Labrador
Nova Scotia
PEI
Saskatchewan
INTENTION TO ALLOW
(LEGISLATION NOT PASSED YET)
Manitoba
No change expected
Quebec
Source: Mackenzie Financial
Rob Carrick