A Guide to Naming Beneficiaries for your RRSP and RRIF
You’ve been diligent in saving and investing in your retirement accounts for your future. What happens to these funds on your death? When you opened your accounts long ago you probably named beneficiaries when filling out your application. Did you give it any thought?
For many of us, RRSP and RRIF assets could very well be the largest tax liability we own. Depending on the value, these holdings can easily be taxed as high as 54%, depending on your province, unless you name a “qualified beneficiary.”
Naming your RRSP/RRIF beneficiaries is very important to avoid leaving tax headaches to your heirs.
When you open a RRSP or a RRIF, you are opening a specific contract under the Income Tax Act which allows you to designate one or more beneficiaries who will receive the proceeds upon your death.
You can name anyone you want as beneficiary. Make sure you understand the tax consequences of your decision.
There are 3 types of beneficiaries
1. Qualified beneficiary
Taxes can be deferred by naming your spouse (by marriage or common law) or your financially dependent children or grandchildren as qualified beneficiaries.
Spouse: In most cases this is the easiest solution. The RRSP assets can be transferred to the spouse’s own RRSP (or RRIF). The funds are included on their tax return, but there will also be an offsetting deduction for the same amount, so no tax is paid on the rollover. The actual transfer must be made before December 31 of the year following the death of the plan holder. The spouse will only pay tax on withdrawals from the plan.
Dependent Children or grandchildren: The child must be financially dependent on you at the time of your death and either a minor or mentally or physically infirm. In the case of a minor child who is not infirm a term annuity must be purchased with the plan assets that will make payments each year until the child reaches age 18. For a child who is infirm, the proceeds can be transferred on a tax-free basis to his or her own RRSP (or RDSP if they have available contribution room) or can be used to buy an annuity. In both cases, taxes are paid on the payments or withdrawals made.
2. Other beneficiary
Adult child, other relative, or friend: No tax-deferred options are available if your children are adults and not infirm, even if they are financially dependent on you. Proceeds will be fully taxed on death. The entire RRSP proceeds will go to the beneficiary. The tax liability will go to the estate, which will likely leave less money than you intended for your other beneficiaries so this must be carefully considered.
Charity: You can name a registered charity as your RRSP beneficiary. The final tax return will be entitled to receive a donation credit of 100% of net income in the final two years. This means that the tax on the collapsed RRSP could be avoided completely. This is a great opportunity for individuals to donate money to their favourite charity that would otherwise have gone to the government in the form of taxes (and a good choice on the death of the second spouse).
3. Your estate
Taxes will be paid on the final return for the value of the RRSP. The assets will also be subject to probate fees. The remainder will be paid out to your heirs.
An additional beneficiary option for a RRIF
When you convert your RRSP to a RRIF it becomes a separate plan, so you need to make sure you name a beneficiary again on the documentation. It doesn’t have to be the same person as on your RRSP.
The options for beneficiaries are the same as for your RRSP with one exception.
You can name your spouse as successor annuitant instead of beneficiary. In that case the plan will pass to your surviving spouse intact and the RRIF payments will continue to be paid without interruption. This option avoids a lot of paperwork and worry for your spouse at a stressful time.
Taxes on death
Generally, the deceased plan holder is considered to have received an amount equal to the fair market value of the plan. With the exception of a tax-free transfer to a qualified beneficiary, this amount has to be included in the deceased’s income on the final return and the estate is responsible for paying the tax liability.
If there are not enough assets in the estate to pay the taxes owing, the beneficiaries of the RRSP/RRIF account will be liable for paying the tax on behalf of the deceased. If your RRSP/RRIF is your only major asset it would be preferable to name your estate as beneficiary.
All income earned after the death of the plan holder and before it is distributed is taxable to the beneficiaries. Interest and dividend income are taxed as ordinary income and not eligible for the dividend tax credit. If investments are sold before distribution, any capital gains or losses are reported by the beneficiaries.
RRSP/RRIF money can be transferred tax free to a qualified beneficiary. But if the plan holder dies early in the year and has little taxable income for the year, consider deregistering part of the plan and including it in the terminal tax return. Not only would the tax hit be minimal, the surviving spouse benefits from a welcome additional lump sum.
The bottom line
Naming a beneficiary is a very important part of tax and estate planning. You can name your beneficiary directly on your RRSP/RRIF application (the easiest way), or you can make the designation in your will (the only acceptable way in Quebec).
The RRSP (or RRIF) will not be included in the value of your estate for probate purposes. The funds will be transferred directly to the beneficiary. This may result in significant savings by avoiding being included in the calculation of probate fees.
Make good beneficiary choices so you don’t unintentionally cause inequitable treatment of your heirs, or unexpected tax consequences to them. Check with your financial institution to confirm what you have on file.
Finally, review your RRSP/RRIF beneficiary designations whenever there is a change in your personal circumstances.