Tax Free Savings Accounts (TFSAs) and Registered Educational Savings Plans (RESPs) are investment drivers that many young families with newborns or young children are eager to take advantage of. The TFSA allows anyone over the age of eighteen and with a valid social insurance number to contribute a certain amount of money annually to a specific investment account, where any income earned is tax free, allowing them to reduce their annual tax burden while simultaneously setting money aside for need in the future. The RESP, on the other hand, serves the dual role of providing a tax deferral opportunity to the subscriber, while also helping the subscriber set money aside for their children’s (beneficiaries’) future education – paid out in the form of educational assistance payments (EAPs).
While both the TFSA and the RESP provide attractive options for couples looking to maximize the utility of their income, both for themselves and their children, there are pitfalls that can and do arise in the case of the unexpected passing of one or both spouses; pitfalls which could significantly hinder the transfer and execution of their investments and wealth. With that said, let us take a moment now to review, for each of the TFSA and RESP respectively, the pitfalls that can arise and how we can work to preemptively solve the challenges these families would face.
Pitfalls with the TSFA:
In the case of the TFSA let’s look at a situation where both spouses hold separate TFSA accounts, and one of them passes unexpectedly.
Generally speaking, on the passing of that spouse, their TFSA account will be collapsed. At this point, the executor will distribute the funds to their designated beneficiaries – which will, in all likelihood, be the surviving spouse. Under this model, the surviving spouse will immediately run into a couple of challenges. Firstly, they will only be able to reinvest the proceeds from their spouse’s TFSA account if they have sufficient unused contribution room available in their own account. Secondly, even if the designation is made to treat the payment from the deceased spouse’s TFSA as an exempt contribution to the surviving spouse’s TFSA, this is subject to certain restrictions and limitations:
- Payment must be received by the surviving spouse before the end of the year following the passing of the deceased.
- The designation to treat the payment as an exempt contribution must be filed within thirty days after the transfer date or the contribution amount allowed will be limited by the room in the surviving spouse’s TFSA.
- Any additional investment income earned on the amount within the deceased spouse’s TFSA after the passing of that spouse and up to the transfer date is taxable to the surviving spouse, eliminating the benefits of the TFSA.
In order to avoid these pitfalls, there are certain steps that the family can take to ensure that they maximize the benefits of the TFSA, even in the event of the unexpected passing of one of the spouses. To do this, in contract or in their will, each spouse should name the other as a successor holder to their TFSA account. We should note that this only applies in provinces that recognizes TFSA beneficiary designations; however, if eligible, the surviving spouse will become the holder of the TFSA account with the passing of the deceased spouse.
Under this model, any new income earned on the account will not be taxed, because the account will not be collapsed – it will simply change ownership. At the same time, this allows the surviving spouse to withdraw amounts from the deceased spouse’s account tax free if needed. Should the surviving spouse wish to streamline their accounts by reducing the number in its entirety, they can transfer the funds collectively from one account to the other without affecting the available contribution room, and without the added stress, deadlines, and associated consequences surrounding filing a designation.
Pitfalls with the RESP:
In the case of the RESP let’s look at a situation where both spouses are joint subscribers to an RESP they have set up for their child, and the last of the spouses (and so the last joint survivor) passes with no specific provisions set out in their will regarding the RESP.
In this case, upon the passing of the last surviving spouse, the RESP will fall into that spouse’s estate. Since, under this model, no provisions have been outlined in the will on how to deal with the RESP, it will be collapsed and form part of the residue of the estate. The immediate challenge here is that now that the entire amount has become part of the estate, and it in its entirety must be distributed out to any beneficiaries in the same manner as any and all other assets of the estate. In the case that there are multiple beneficiaries, this means that the money set aside for that family’s child – including the original contributions – will likely not go to the child’s education as intended, but instead be spread out across a number of different people as prescribed by the will. Moreover, with the collapse of the RESP, the estate will pay tax retroactively on any investment income earned on the RESP since its inception, and any Canada Education Savings Grants earned on the RESP will need to be paid back to the government. Essentially, with the passing of the last surviving spouse, the RESP fails to fulfill its purpose.
The solution to this challenge is one that, while fairly straightforward, is often missed by younger families faced with the unexpected passing of both spouses. Here, the spouses will need to name a trustee as a successor to their RESP, which is often the testamentary trust.
Under this model, the trustee of the estate is empowered to continue administering the RESP, meaning it will not need to be collapsed. Moreover, the trustee can continue to fund the RESP using the assets of the estate. Along with avoiding the repayment of government grants, investment income from the RESP will only be taxed as funds are withdrawn – rather than immediately in aggregate, and funds from the RESP will be directed to the child named in the RESP rather than distributed amongst any other beneficiaries. This, in essence, gives the parents of the child the opportunity to direct the RESP as intended through the execution of their will.
At the end of the day, any situation where one or both spouses in a family passes will be one fraught with complications. Yet there are financial solutions in place that can help give those families direction even in the worst of times. TFSAs and RESPs are both valuable pieces of financial architecture, and ones that can certainly be used to a family’s advantage. As you continue to build your financial portfolio, take a look to the future and plan for those unexpected circumstances. Doing so will not only provide security for your family in the long term, but will provide you peace of mind in the now.
Written by: Joe Figliomeni, CPA, CA