Q. I will soon be converting my RRSP into a RRIF. Currently the beneficiary is my estate. I was told I could save money if I named my children as equal beneficiaries. What are the tax implications of doing this?

When there is no “qualified” beneficiary – i.e. spouse or dependent child or grandchild – a RRSP/RRIF plan holder can name either one or more individuals, or his or her estate, as beneficiary. Each of these choices has different consequences.

Designating a RRIF beneficiary

Estate as beneficiary

When the estate is named as beneficiary, the entire amount of the RRSP/RRIF is combined with all your other assets and subject to probate.

Taxes are paid by the estate on the final year-of-death tax return.

After all taxes, fees and other expenses are paid, the remaining estate assets are distributed as instructed by you in your Will.

Naming one or more individuals

If you name your children as beneficiaries, the RRSP/RRIF is not subject to probate.

On death, the financial institution will pay the entire plan proceeds to the named beneficiaries. Nothing is held back for tax liabilities.   The estate is responsible for paying the income tax on the full amount.

The beneficiaries receive the investment portfolio at its fair market value on the date of death.

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.

Can the estate pay the bills?

RRSP/RRIF proceeds and all other income received in the year of death (e.g. salary, CPP, dividends) are combined. This can push the total income into the deceased’s highest marginal income tax bracket. Depending on the remaining amount, a RRSP/RRIF can generate a six-figure tax bill.

Consider that if any Tax Free Savings Account and life insurance proceeds are also paid directly to beneficiaries, there may not be enough money left in the estate to pay bills such as funeral costs, capital gains on a cottage, probate fees and taxes.

If the estate is not large and there are not enough assets to pay the tax, the Income Tax Act considers the beneficiaries jointly liable.

Final thoughts

When RRSP and RRIF plans are opened, you are asked to name a beneficiary. Sometimes they are given without much thought at the time, and often never referred to again.

However, beneficiary designations should be carefully considered as part of your overall estate planning.

Problems can be created when estate planning is done with the aim of reducing taxes and fees at all costs.

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