A tax-free savings account (TFSA) is a great way to save. You can put away money in one for a down payment on a home, a vacation or your retirement. But for any savings or investment account, it's important to answer one question: Who gets it after you’re gone? For TFSAs, there are two ways to leave your money to your spouse. You can make that person a “beneficiary” or a “successor holder.” People commonly understand what the first term means; the second, not so much. And the difference between the two can have financial implications.

What’s the difference between a beneficiary and a successor holder?

A beneficiary gets the money, while a successor holder gets the account.

"Only a spouse or common-law partner can be a successor holder," Sun Life Financial advisor Melanie Adams1 says. "But you can name anyone you choose as a beneficiary." She says if you open your TFSA through an advisor, your advisor will explain the two choices. But if you open a TFSA online, you may not know the difference.

If you want your spouse or common-law partner to get your money, it's important to understand your options. That’s because your choice can add up to a lot of money in additional taxes.

"The limits to TFSAs are growing and the amount of money sitting in these plans is growing," Adams says. "This is going to become more and more of a planning and tax issue." The current annual contribution limit is $6,000. But what if you’ve been eligible to own a TFSA since they came on the scene in 2009? And what if you’ve put in the maximum allowed each year? Then you’re looking at $63,500 in your TFSA – plus any investment growth along the way.

The simple choice: Name your spouse as the successor holder of your TFSA

Being the successor holder means your spouse or common-law partner can take over your TFSA after you die. That’s regardless of how much contribution room there is in that person’s own plan. "So [your TFSA] would basically roll over into their own TFSA," Adams says. "It will not affect their own contribution room in any way."

The successor holder becomes the new owner of the TFSA, and it stays tax-exempt. This also avoids probate fees, which is the tax the government charges to validate your will. That’s because the TFSA isn’t part of your estate and instead goes directly to your spouse or common-law partner. The successor holder can choose to keep separate TFSAs or merge them.

IMPORTANT NOTE: The simplest choice isn’t always the best. It’s usually a good idea to name your spouse as successor holder. But sometimes it may be wiser to stick with the beneficiary designation. That can be true with some kinds of investments, such as those with guaranteed death benefits. Speak to your advisor for more information.

The common choice: Name your partner as the spousal or common-law beneficiary for your TFSA

You can name your spouse or common-law partner a beneficiary but not a successor holder for your TFSA anywhere in Canada except Quebec. That means your money can still go into your partner’s TFSA without using up contribution room. Your partner has until the end of the year following the year of your death to make the transfer. But it takes a little extra paperwork afterward. “Spouses and common-law partners have to take the extra step of filing an RC240 form with the Canada Revenue Agency (CRA),” Adams explains. This frees them from having to pay tax on the money going into their accounts. They have to file the form within 30 days of transferring the money from your TFSA.

What if your spouse or common-law partner doesn’t file the RC240 form in time? Then the money in your TFSA will still roll over, as long as the transfer was within the deadline. They will have to use their own TFSA contribution room to cover the amount. And what if there isn’t enough room? Then there will be a penalty of 1% per month for anything above the maximum contribution allowed. If your partner has no contribution room and your TFSA is worth six figures, that’s a significant penalty. It’s also an unnecessary use of TFSA contribution room.

The complex choice: Choose a non-spousal or common-law beneficiary for your TFSA

What if you don’t have a spouse or common-law partner? If you make your children or siblings the beneficiaries on your TFSA, they are called non-spousal or common-law beneficiaries. They don’t have the option of filing the RC240 form. After your death, the CRA will no longer consider your account a TFSA. That’s even though any investment growth in it up to the date of your death will be tax-free. Your beneficiaries can transfer the money to their own TFSAs, if they have contribution room. Whatever your beneficiaries can’t transfer (or choose to not transfer) to their own TFSAs will be treated as cash. The CRA will treat it like the money in a bank account. Your beneficiaries will also have to pay tax on any money that grows in your TFSA after your death.

Which choice is best for you?

"It’s really vital to understand the importance of the successor holder for their spouse or common-law partner," Adams says. It’s not an automatic designation, she adds. While there are two options to sign on the form, most people choose the more familiar term 'beneficiary.'

"It’s a huge benefit for spouses or common-law partners," Adams says. "Having that TFSA money transfer into their plan seamlessly won’t affect their contribution in any way."

If you choose a successor holder, there won’t be extra paperwork to worry about in the midst of mourning. It’s a small detail, but it can make a big difference.

Read more about TFSAs:

1 Melanie Adams,* BA, PFP. Adams and Associates Financial Solutions Inc., Sun Life Financial advisor.
* Mutual funds offered by Sun Life Financial Investment Services (Canada) Inc.
Sun Life Assurance Company of Canada is a member of the Sun Life Financial group of companies.