Even this basic step in estate planning for such registered accounts is fraught with pitfalls
Earlier this year, a study from BMO Financial Group found a rise in the average amounts held in RRSPs across the country, suggesting an increased interest in retirement saving. But the truly future-focused Canadian investor should plan for every contingency, and that means choosing a beneficiary in case the worst happens.
According to the Canada Revenue Agency, RRSP carriers must designate a beneficiary before any amounts are paid out. RRSP may name a beneficiary in their will or, if they don’t live in Quebec, on the plan documentation. The choice may be straightforward in many cases — but there are still potential pitfalls to keep in mind.
For instance, some may choose to specify a beneficiary in both places, but fail to keep them consistent. In a note titled Estate planning for your RRSP/RRIF, RBC Wealth Management says that in such cases, the later designation supersedes the earlier one. But if the financial institution holding the plan is unaware of a later designation the plan-holder made in their will, the institution will pay the assets directly to the beneficiary listed on the plan upon the RRSP holder’s death.
“This could lead to conflicts between your heirs who may seek legal remedies and incur unnecessary expenses,” the note said.
Plan-holders have many options in designating beneficiaries, including their spouse, offspring, or even a third party. A financially dependent child or grandchild can be good for tax-planning purposes as it allows for a distribution of some or all income to the beneficiary, who likely has minimal income.
“Aside from being able to minimize the tax burden on your death … it may be possible to defer the taxation of your RRSP/ RRIF if your beneficiary is a minor or disabled,” the note added. But some provincial or territorial laws prevent minor children from directly receiving RRSP proceeds, particularly as minors do not have the legal capacity to receive any proceeds paid to them or provide a valid discharge to the financial institution administering the plan. For that reason, payments are generally made to a parent, court-appointed guardian of property, the Public Guardian or Trustee, or into court, depending on the value of the RRSP on death and applicable laws.
“If the RRSP/RRIF proceeds must be paid into court, there will be limited access to these funds until your child reaches the age of majority,” the note said. The opportunity to defer taxation of the RRSP may also be lost if the court is unwilling to purchase an annuity for the beneficiary. Those applying to be appointed as guardian of the minor child or grandchild’s property may also find the process time-consuming and expensive.
The case is different for spouses, who may be a legally married spouse or a common-law partner. They may transfer the plan assets directly to their RRSP or RRIF as a tax-deferred rollover, though this isn’t possible if they’re over 71 years old at the end of the year the transfer is made. As an alternative, they may transfer the funds to an issuer and purchase an eligible annuity, in which case the tax doesn’t kick in until the spouse receives a payment from the annuity.
But if the RRSP holder had minimal income in the year of their death or had unused losses carried forward from previous years, the note suggested, it might be better to determine the amount of RRSP proceeds to be taxed on the plan-holder’s final return or in the spouse’s hands that would effectively dampen the blow from tax.