When we think of RRSP planning, we often think about whether it makes sense to buy RRSPs or how to invest your RRSPs. One question we may not think about addressing right away is “What Happens to your RRSPs when you die?” Although it’s not something we like to think about it is an important issue with RRSPs, especially when it comes to tax.
On death, the RRSPs are deemed to have collapsed. The tax consequences really depend on who is listed as the beneficiary of the RRSP. 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 one of three parties:
- 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.
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received can be transferred to an RRSP set up for the child, meaning the funds will not be taxed until the funds are withdrawn.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.
Other considerations:
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.
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.
Listing a charity as a beneficiary
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.
Listing the estate as the beneficiary
Many people choose not to do this for two reason. Firstly, the amounts become fully taxable to the estate and secondly, the RRSP form part of the estate and are also subject to probate fees. If there is no spouse, many people prefer to list their children as beneficiaries, which can help avoid probate but not tax. In this case, it is important to watch the tax trap that can occur when someone other than the spouse is listed as a direct beneficiary of the RRSPs or RRIF.
Don’t die with too much RRSPs
I’ve said it before and I will say it again . . . the worst thing you can do is die with too much RRSPs. It may sound odd because most people are supposed to spend their money in retirement but far too often people get focused on deferring RRSP income so they do not have to pay tax and the fear of running out of money. As you can see, it is critical that people take the time to do some proper estate planning, which includes thinking about beneficiary designations. More importantly, I encourage people to think about a spending plan for their RRSPs as part of their overall financial plan. Choosing the right beneficiary is a significant part of estate planning.
