Naming a beneficiary for your Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF) seems simple enough, doesn't it?
Well, not so fast. Here are some tips and traps to consider when it comes to naming beneficiaries.
Who have you named as beneficiary of your RRSP or RRIF? There are five common options, each with their own implications.
Your spouse. Most folks will name a spouse as beneficiary of their registered plans. And this makes sense from a tax perspective.
Here's how the tax law works: Upon your death, you'll face tax on the full value of your plan. If you name your spouse as beneficiary of the plan, you'll no longer face tax on that value upon death, but your spouse will now be taxed on that value. Your spouse can then defer the tax on the plan assets by rolling them into his or her own plan.
Your dependent children. It's possible to achieve a tax-deferred transfer of your plan assets to your children or grandchildren, as with your spouse, if those children are minors, or are mentally or physically infirm, and are financially dependent on you at the time of your death.
In the case of a minor child, the only option is to buy an annuity that will pay out amounts each year to age 18. For infirm adult dependents, the assets can be transferred to his or her RRSP.
No tax-deferred transfer is allowed if the children are adults and are not mentally or physically infirm, even if they are financially dependent on you.
Your estate. If you name your estate as the beneficiary of your plan, there will generally be income tax owing on the value of the plan assets on your final tax return.
Be aware, however, that it's possible for your executor in this case to make a joint election with your spouse (or a qualifying financially dependent child) to make a tax-deferred transfer of the plan assets to your spouse's (or child's) plan (or annuity for the child).
There will be probate fees payable on the value of the plan assets. Still, it can make sense to name your estate as beneficiary in some cases (see the strategies section).
A charity. It used to be that naming a charity as the beneficiary of your RRSP or RRIF would not have given rise to a donation tax credit in your year of death. Today, you can name a charity as beneficiary and you'll be entitled to a donation credit on your final tax return for the value donated. This will effectively offset the tax owing on the plan at the time of your death.
Others. If you name someone other than those listed here as the beneficiary of your RRSP or RRIF, you'll face tax on the value of the plan in your year of death.
There are two common ways to name someone as the beneficiary of your registered plan.
On the application: Simply name your beneficiary on the plan application form itself. This approach makes the most sense in most cases.
Now, if you're hoping to name more than one person as beneficiary, and you want each person to receive a different percentage of the plan, you may not be able to accomplish this by simply naming all those beneficiaries on the plan application form. Most financial institutions won't allow this because it comes too close to a "testamentary disposition," and imposes duties on the financial institution that are more appropriately carried out by your executor.
If you want to split your plan in unequal shares, it generally makes the most sense to name your estate as the beneficiary and then leave instructions in your will as to the division of those assets.
In your will: The second common approach to naming a beneficiary of your registered plan is to make a designation in your will. I'm not a fan of this idea, however. Why? Two key reasons.
First, if your will is ever revoked (by a subsequent will, or a marriage, for example), then your beneficiary designation is also revoked, and the original beneficiary designation you might have made on the plan application form is not reinstated in this event. If your designation in the will is revoked, your plan assets could fall into your estate, resulting in probate fees, an unintended distribution to certain beneficiaries of your will, or subject to the claims of someone contesting your will.
Second, your plan administrator may still pay the plan assets to the person named as beneficiary in the plan application form unless you remember to notify them that a new designation has been made in your will. Very few people remember to do this.
Here are a few strategies to keep in mind regarding beneficiaries:
It's possible for your executor to elect to have some of your RRSP assets taxed in your hands upon your death, even if you've named your spouse or qualifying dependent child as beneficiary. This can make sense where you die early in the year, and therefore have little income in your year of death, but have personal tax credits, losses or other deductions available in the year of death to offset some of that taxable RRSP income.
It can make sense to name your estate as beneficiary of your plan when:
(1) You want an unequal distribution of your plan among beneficiaries, (2) there are conditions or contingencies you want met before a beneficiary has a right to the plan assets, (3) the plan assets are to be held in trust for the beneficiary, or (4) where specific bequests could become a problem (see the next tip).
Suppose you die with a registered plan, and a tax bill is triggered as a result. Your plan beneficiary will receive those assets without any withholding tax.
So who will pay the taxes? They will be paid from the remaining assets of your estate, if they're sufficient. This could mean that your other beneficiaries (those who didn't get the registered plan) could be shortchanged. This may not be fair, and the problem could be solved by naming your estate as beneficiary of the plan, causing all the beneficiaries of the estate to share the tax burden.
Succession law is a provincial matter, and laws can change over time. So be sure to speak to a lawyer in your province about your beneficiary designations, particularly if you're making a designation outside the plan application.
Tim Cestnick is a principal with WaterStreet Group Inc. and author of Winning the Tax Game among other titles.
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