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Keep your beneficiaries in mind after a divorce

Sometimes wedded bliss must give way to harsher realities. Today, I want to talk about divorce, and how it affects your RRSP beneficiary designations. You'll want to avoid some traps here.

The traps

When two people divorce, they often forget to look after all of the nitty gritty financial details. Consider your registered retirement savings plan and registered retirement income fund for example. A divorce does not, in most provinces, result in a revocation of a former spouse's entitlement as a designated beneficiary of those plans. That is, your ex- may still be entitled to your registered plan assets if you're not careful.

Consider the story of Diane Slater and Henry Klassen. They were married in June, 1982, and divorced in June, 1994. While married, Mr. Klassen was the annuitant of RRSPs with Ms. Slater designated as beneficiary.

After their divorce, Mr. Klassen, who kept the RRSPs in the split-up, failed to change the beneficiary of the plans, and then he died in November, 1994, just five months after the divorce.

Two issues arose when Mr. Klassen died. First, who should be entitled to the RRSP assets -- Ms. Slater, or Mr. Klassen's kids? Second, if Ms. Slater was entitled to the RRSPs, who is liable to pay the tax on the RRSPs? (Since Ms. Slater was no longer Mr. Klassen's spouse, there would be no tax-deferred rollover to her.) The first issue was simple. The court ruled that Ms. Slater was entitled to the RRSPs.

When a divorced person fails to change the beneficiary on his or her plans, and failing appropriate wording in a separation agreement, the courts generally assert that the deceased could have changed the beneficiary designation easily and, failing to do so, the ex-spouse is entitled to the assets.

On the second issue, Mr. Klassen's kids lost again. Subsection 146(8.8) of Canadian tax law causes the RRSP assets to be taxable in the hands of the deceased if the RRSP is left to anyone but a surviving spouse.

The result? Mr. Klassen was taxable on the RRSP assets in the year of his death, and his estate (not Ms. Slater) was liable for the tax bill.

Things can get even more complicated if you make an RRSP beneficiary designation in your will, and later divorce. Consider Jack and Jill. Suppose that Jack and Jill are married, Jack is the annuitant of RRSPs, and has named Jill as beneficiary on the RRSP application form. Then, Jack makes his will and names Jill as beneficiary of his RRSPs in his will as well. The couple then divorces.

Jack is a smart guy. After the divorce he goes back to his lawyer who draws up a new will that revokes his previous will and leaves everything to his brother. The new will contains no RRSP clause. Then Jack dies.

Who gets Jack's RRSP? Much to the chagrin of Jack's brother, Jill gets the assets. You see, while Jack's second will revoked his first (and therefore revoked the RRSP beneficiary designation in the first will), it did not revoke the beneficiary designation made on the RRSP application form itself.

The tips

The law surrounding the designation of beneficiaries on RRSPs, RRIFs, and life insurance contracts is complex, and can vary from one province to the next. Still, your strategy should be the same. After a divorce, be sure to the change the beneficiary named on your registered plans with your financial institution itself. And if you've named a beneficiary of those plans in your will, be sure your lawyer includes in a new will (subsequent to your divorce) a clear revocation of all previously made RRSP beneficiary designations.

Tim Cestnick, FCA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC Ltd.

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