One area of tax planning that does not receive enough attention is the designation of beneficiaries when it comes to Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs). When you open up an RRSP or RRIF, you are opening up a special contract under the Income Tax Act, which requires that you designate one or more beneficiaries.
Far too often, this is done too casually and without enough thought. More importantly, as your circumstances change, like marriage, divorce or children, you should consider reviewing your beneficiaries to make sure you have the right people designated.
Taxation of the RRSPs/RRIFs at death
The first place to start in understanding whom to list as a beneficiary is to understand the taxation of these contracts at death.
The general rule for an RRSP or RRIF is that the value of the RRSP or RRIF at the date of death is included in the income of the deceased for the tax return for the year of death. There are three exceptions to this rule where the tax can be deferred if the beneficiary of the RRSP, RRIF, or estate is:
- the spouse (includes common-law partner)
- financially dependent child or grandchild under 18 years of age, or
- financially dependent mentally or physically infirm child or grandchild of any age.
Who should be the Beneficiary?
For obvious reasons, there are tax benefits to naming your spouse, dependent children/grandchildren under the age of 18 or dependent adult children who are mentally or physically inform.
That being said, anyone can be named the beneficiary. Most often, it is the spouse, children or the estate that are named but it does not have to be that way.
Your spouse as the beneficiary
The spousal rollover provision allows a spouse that is listed as the beneficiary to rollover the amount of the deceased’s RRSP into their RRSP without any tax consequences. Obviously for planning purposes, it is wise in most cases to list a spouse as a beneficiary.
Dependent child or grandchild
If a financially dependent child or grandchild under the age of 18 is the beneficiary of the RRSP, the dependent child under the age of 18 can roll the RRSP into an annuity that pays the child to the age of 18. For example, a 7 year old who is the beneficiary of a RRSP can have the RRSPs rolled into an 11-year annuity, which would spread the tax over an 11-year period.
Dependent infirm child or grandchild
For dependent infirm children, the amount received can be transferred to an RRSP set up for the child, meaning the funds will not be taxed until the funds are withdrawn. It is important to weigh any tax savings against the practical issues related to having funds go into the hands of an infirm child.
What happens to the Home Buyers Plan at death?
If there is an outstanding balance remaining in the RRSP home buyer’s plan, the outstanding balance will be included as income on the deceased’s final income tax return unless the spouse was named as beneficiary and had taken out a home buyer’s amount at the same time. In this case, the beneficiary has two options:
- the outstanding amount can be added to the final tax return of the deceased spouse or,
- the entire RRSP, including the Home Buyers’ Plan balance, can be rolled over to the beneficiary’s RRSP.
RRIFs and Beneficiary Designations
When you are converting your RRSP to a RRIF, you are setting up a new contract and you must designate a beneficiary at that time. If you assume the RRSP designation would continue to apply, that would not be the right assumption.
Successor Annuitant for RRIFs
For RRIFs, when naming your spouse as beneficiary, you are given the option of having your spouse receive the RRIF as a lump sum or choosing your spouse as the “successor annuitant” to the RRIF.
If a successor annuitant election is not made, the deceased’s RRIF will be collapsed causing a disposition of the investments in the RRIF followed by a rollover to an RRSP or RRIF of the surviving spouse. There may be several disadvantages to this. It may not be a good time to sell the investments in the RRIF or there may also be selling costs to consider. Also, there is the issue of preparing all of the paperwork at a difficult and stressful time for the surviving spouse.
The successor annuitant designation is effortless. The spouse simply takes over from the deceased and continues to receive RRIF payments in his/her place. The investments in the RRIF are not affected by this, as there is no need to execute a new contract.
One key benefit is if a beneficiary is designated in the RRIF contract, the RRIF value will not be included in the calculation of probate fees on death. While probate fees are not as significant as income taxes, such a simple step will ensure that there is more available for your beneficiaries.
Giving money to charities
The most significant changes affecting estate planning relates to the ability to receive a credit of up to 100% of taxable income for donations made through a Will. This means that the tax on RRSPs and RRIFs arising from the death of the annuitant can be avoided completely if a donation equal to the value of the RRSP or RRIF is made in his/her Will.
This is a great opportunity for individuals to donate money to their favorite charity that would have otherwise gone to the government in the form of taxes.
RRSPs, RRIFs and estate planning
As you can see, the designation of the beneficiary in your RRSPs and RRIFs is one of the most important factors in how much taxes you are going to have to pay at the time of death. Yet, it is astonishing how many people make this decision without regard to the overall estate plan or simply forget to designate a beneficiary.
When setting up a RRSP or a RRIF, it is crucial that you make good beneficiary choices. It is equally important that you review the beneficiaries in the RRSPs, RRIFs and through your will from time to time. If you haven’t done this in a while, review it sooner than later.