RRSPbeneficiary

RRSP Beneficiary Designation

Passing your Estate to your Children

Part 1: Your RRSP/RRIF

 

For most families, it is on the death of the surviving spouse where taxes take their toll – that’s because on their death:

  • all assets of the deceased are the deemed disposed at market value resulting in capital gains taxes;
  • the RRSPs and RRIFs are deemed collapsed and their fair market value becomes ordinary income and taxed in the deceased’s final tax return; and
  • there may be foreign inheritance and transfer taxes on foreign assets on top of the Canadian taxes.

Due to Canada’s progressive income tax rates, the more income you have, the higher the rate of tax you pay. As such, the Taxable Capital Gains and RRSP/RRIF income may result in a substantial amount of this income being subject to tax at the highest marginal tax rate.

In this article we’ll look at estate planning surrounding your RRSP/RRIF.

 

  1. What Happens to your RRSP/RRIF on death?

The general rule is that, on your death, the fair market value of your RRSP/RRIF is fully taxable as ordinary income in your final return.

The exception to this rule is where a qualified beneficiary of your RRSP/RRIF is designated as beneficiary where, on your death, he or she receives an amount from your RRSP/RRIF (called a refund of premium). In this case, the refund of premium paid to the qualified beneficiary is taxed in their hands. Furthermore, the qualified beneficiary may be able to transfer this income to their RRSP/RRIF where they obtain an offsetting deduction. The net effect of this is that your RRSP/RRIF is transferred to your qualified beneficiary without any tax consequence.

To summarize, when you name a qualified beneficiary as a beneficiary of your RRSP/RRIF, the date-of-death value of your RRSP/RRIF may be taxed in your hands in your final return, taxed in your child’s hands, or transferred to the beneficiary’s tax deferred plan.

 

  1. Who is a Qualified Beneficiary?

A qualified beneficiary is:

  • your spouse or common-law partner, or
  • a financially dependent child or grandchild (we’ll refer to them both as a child). A child is considered to be financially dependent on you at the time of your death if the child ordinarily resided with you at that time and they meet one of the following conditions:
  • the child is not mentally or physically impaired and their net income for the previous year (shown on line 236 of their tax return) was less than the basic personal amount (line 300 from Schedule 1) for that previous year; or
  • the child or grandchild is impaired in physical or mental functions and their net income for the previous year was equal to or less than the basic personal amount plus the disability amount (line 316 from Schedule 1) for that previous year.

 

  1. Eligible Dependent as Beneficiary of your RRSP / RRIF

Where a financially dependent child or grandchild is the beneficiary of your RRSP/RRIF, the following tax-deferred transfers are available to this dependent child:

  1. Financially Dependent Child who is Physical or Mentally Infirm
  • (i) Rollover to an RRSP, RRIF or qualifying annuity

Where the financially dependent child, regardless is an adult or a minor (under 18 years of age), is physically or mentally infirm, the RRSP/RRIF proceeds can be rolled over tax-deferred to an RRSP, RRIF or qualifying annuity (for example: a life annuity) for the child.

  • (ii) Rollover to a Registered Disability Savings Plan (RDSP)

Where the financially dependent infirm child or grandchild is the beneficiary of your RRSP/RRIF or pension plan and receives, as a consequence of your death, proceeds from these plans, these amounts may be rolled over (up to a certain limit) to a Registered Disability Savings Plan (RDSP) of the financially dependent infirm child.

The maximum transfer amount is $200,000 which is reduced by the amount of all contributions and rollover transfers that have previously been made to any RDSP. The amount of money transferred into an RDSP will form part of the $200,000 lifetime contribution limit. The Government will not pay matching Canada Disability Savings Grants on the money you transfer.

For example, if there is already $50,000 in private contributions in an RDSP, the amount rolled over from an RRSP, RRIF and RPP cannot exceed $150,000.

A rollover to an RDSP can only occur if the child is eligible for the Disability Tax Credit and the deposit into the RDSP occurs prior to December 31st of the child’s 59th year.

 

  1. Minor Child – NOT physically or mentally infirm
  • (i) Rollover to a fixed-term annuity to age 18

If the child or grandchild is not physically or mentally infirm and is under 18, your RRSP/RRIF proceeds can rollover tax-deferred where the proceeds are used to purchase a fixed-term annuity.

The annuity can provide for payments based on a period of not more than 18 years minus the child’s or grandchild’s age at the time the annuity was bought. The payments from the annuity have to start no later than one year after the purchase.

The annuity payments will be taxable as ordinary income to the child in the years they are received.

 

 

  1. What if the beneficiary designation is not done in your RRSP/RRIF plan document?

In the event that your estate is the beneficiary of your RRSP/RRIF, the Executor of your Will and a qualified beneficiary may jointly elect to treat that beneficiary as if he or she was designated as beneficiary for all or a portion of your RRSP/RRIF proceeds. Some or all of the RRSP/RRIF proceeds could then be taxed in the child’s hands. And if that child qualifies for one of the above rollovers, then some portion or all of the proceeds might be rolled over to their RRSP/RRIF, RDSP or towards purchase of a qualifying or fixed-term annuity.

 

  1. What if I name my healthy adult children as beneficiaries?

Where you name your healthy adult child who is financially dependent on you and resides with you, your RRSP can be transferred to him or her and taxed in their hands. Although there is no tax deferral, the tax on your RRSP / RRIF can use your child’s marginal tax rates which may save taxes.

 

If you choose a beneficiary of your RRSP/RRIF who is not a qualified beneficiary, the fair market value of your RRSP/RRIF as at the date of death is fully taxable as ordinary income in your final return.

 

By naming a beneficiary directly in the RRSP/RRIF plan document, you may avoid probate and legal fees on your RRSP/RRIF assets as these amounts pass outside your estate.

Care must be taken with non-qualfied beneficiary designations where:

  • (i) your chosen RRSP/RRIF beneficiaries are not identical to the beneficiaries of the remainder of your estate.

The danger is that you might unintentionally benefit one beneficiary more than another. This could happen because RRSP/RRIF assets are taxed in the estate, but the gross amount flows to the designated beneficiaries.

For example, if you are a widower and you name one child the beneficiary of your $300,000 RRIF and a different child the beneficiary of your personal chequing account with $300,000, the RRIF beneficiary gets the $300,000, but your estate must first pay tax on the RRSP/RRIF proceeds from the other assets of the estate. If taxes averages out at 40%, then the other child’s entitlement (before factoring in probate, legal and tax costs) would be only $180,000 (= $300,000 x (1 – 40% tax rate)).

  • where you name all of your children as equal beneficiaries RRSP/RRIF

Should one of your children predecease you, on your death, the RRSP/RRIF proceeds may then pass only to your surviving children. As such, the family of your deceased child might then receive nothing. (The financial institution’s RRSP/RRIF Declaration of Trust should be checked to confirm the exact treatment that would occur in such a case. The treatment can vary from one financial institution to another.)

So in naming your children as beneficiaries of your RRSP/RRIF, it is important to review and update your beneficiary designation as family circumstances change.

 

  1. Naming a Trustee of a Trust as beneficiary

Rather than name your adult children as beneficiaries of your RRSP/RRIF, you might instead name a Trustee of a Trust as your RRSP/RRIF beneficiary. The benefits of this alternative include:

  • avoiding probate and legal fees associated with the proceeds and funds end up in a Testamentary Trust which has tax advantages and creditor protection features compared to direct gifts;
  • ensuring that a spendthrift child won’t eat through their inheritance which you prefer to last for their lifetime;
  • ensuring that a deceased child’s family is not disinherited;
  • building marriage/creditor protection provisions into the Trust to help keep the inheritance in the family.

The disadvantage of naming a Trustee is that you need to incur legal costs to have the Trust document created. The Trust could be in your Will, but it is preferable to be a separate document so that your beneficiary designation is not invalidated if you should later update your Will.

 

  1. Charity as beneficiary of your RRSP/RRIF

When a charity is designated as the beneficiary of your RRSP/RRIF (which should be done direct in the RRSP/RRIF plan document to avoid probate), the gift is eligible for the charitable donation tax credit and is deemed to have been made immediately before your death, as long as the RRSP/RRIF assets are transferred to the charity within 36 months of your death. Since the balance in an RRSP/RRIF is treated as income in the year of death, the charitable credit should eliminate the entire tax on the RRSP/RRIF.

For many people, the option of designating a charity as the beneficiary is attractive for two reasons:

  • Flexibility – You don’t commit to giving monies that are needed for your living needs until after you’ve passed away. So, if you live longer than expected or you happen to have higher expenses, the RRSP/RRIF monies are still there to take care of you. The charity simply gets any residual.
  • Supporting your charity rather than the taxman – your donation helps your favourite charity while reducing or eliminating the tax otherwise applicable to the RRSP/RRIF proceeds.

It is important that where a gift is to occur on your death to a charity, that there is a certainty as to the specifics of the gift (the amount and specific property) as well as the charity itself in order to get the charitable credit in your final return. Make sure you include the charity’s proper legal name, business number, and address.

 

  1. When to review your designations

You should review your RRSP/RRIF beneficiary designation whenever there is a change in your personal circumstances such as a substantial inheritance, marriage, separation, divorce, death or birth. If you have converted your RRSP into a RRIF, the RRIF is considered a new plan and you should ensure that you’ve named a beneficiary directly through the new plan documents.

And, if you have not made a beneficiary designation or have your “estate” as the designated beneficiary, consider saving the probate on your RRSP/RRIF by making a designation.

 

The Next Step

This article was not meant to replace professional advice but instead provide you with some tax reduction opportunities to discuss with your advisor.  More information is available.  You might also read Canada Revene publications of RC4177, RC4178 and T4040.

 

If you would like help in developing your estate plan, please contact me. I will work together with your estate planning lawyer to help custom design and implement your estate plan. I provide estate planning at no extra charge to my clients. Call me at (604) 288-2083 or email me at steve@lycosasset.com.

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