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By Alison MacAlpine
Estate planning isn’t generally top of mind when people think about their registered retirement savings plans (RRSPs). Instead, many focus on building up these nest eggs and the tax deduction that comes with them. Others look further ahead to consider how they’ll turn RRSP savings into a retirement income stream.
However, clients should be incorporating RRSPs into their estate plans as soon as they retire, if not before, says James McCarthy, a wealth advisor with Nicola Wealth Management Ltd. in Vancouver. He says it’s important to leave time to draw down the balance strategically to reduce taxes when the RRSP annuitant dies.
In general, the fair market value of RRSP assets on the date of death is taxable alongside any other income the deceased earned that year.
Suppose the RRSP beneficiary is the annuitant’s spouse, common-law partner, financially dependent child under 18, or financially dependent and mentally or physically infirm child or grandchild of any age. In that case, taxes may be deferred by rolling the RRSP assets into the beneficiary’s RRSP, registered retirement income fund, registered disability savings plan or eligible annuity.
However, not everyone has one of these qualifying survivors to receive the RRSP assets.
“Contributing to your RRSP is a very efficient way of saving, but when you pass away it’s a very inefficient way of leaving assets to your beneficiaries,” Mr. McCarthy says.
Here are eight strategies to manage the tax burden associated with RRSPs upon death.
1. Review beneficiary designations
Mr. McCarthy has encountered situations in which people have not designated their spouse as the beneficiary of their RRSP. Even if there’s no qualifying survivor, naming an RRSP beneficiary allows RRSP assets to pass outside the estate, avoiding probate (where applicable). Remember to check in on beneficiary designations regularly to ensure they remain appropriate.
2. Ensure sufficient liquid assets remain in the estate
In some cases, an RRSP may form the bulk of liquid assets in an estate, says Leanne Kaufman, president and chief executive officer of RBC Royal Trust in Toronto. If the RRSP assets pass outside the estate to a named beneficiary who doesn’t qualify for a tax-deferred rollover, non-liquid assets such as real estate may have to be sold to cover the tax bill charged to the estate. So, make sure enough liquid assets remain in the estate or plan to cover taxes another way – for example, with life insurance.
3. Keep probate in perspective
Sometimes, it makes sense to designate the estate as the RRSP’s beneficiary even in provinces that impose a probate fee. That allows the executor to have all assets at their disposal as they pay debts, taxes and administration costs. Furthermore, “it’s a lot easier to set up a testamentary trust with different terms if [the RRSP proceeds] are in the estate versus handing it off directly to a beneficiary,” says Matt Trotta, vice-president of tax, retirement and estate planning with CI Global Asset Management in Calgary.
4. Assess downstream effects on beneficiaries
Ms. Kaufman offers the example of a parent with two children who names one as beneficiary of the RRSP and the other as beneficiary of the residue of the estate. If the intention is for each child to receive equal sums after taxes, it’s critical to plan to cover the taxes for which the estate (not the RRSP beneficiary) will be liable.
5. Match instructions inside and outside the will
Beneficiary designations on registered plans and instructions within the will should match. Mr. Trotta gives the example of a child who is named executor of the will and beneficiary of the RRSP, outside the estate, but where the will provides instructions on how the RRSP should be managed. In such a case, there may be confusion about whether that child is the RRSP beneficiary in their personal capacity or in their capacity as executor. This may lead to questions about whether the RRSP entered the estate.
6. Consider donating RRSP assets
For clients who want to leave a legacy to charity, RRSPs can be a tax-effective source of funds. Mr. McCarthy is seeing growing interest in naming a charity or donor-advised fund as the RRSP’s beneficiary. In that case, the funds pass directly to the beneficiary, avoiding probate (where applicable), and the estate gets a charitable donation tax credit to offset the income inclusion on the deceased’s terminal return.
7. Make an all-encompassing plan
RRSPs shouldn’t be considered in isolation, Ms. Kaufman says. Even when an RRSP will pass outside the estate to a named beneficiary, it should still come up in estate planning discussions and conversations with a lawyer about the will. “It’s critical to think holistically and address all assets and all liabilities and the interconnectedness,” she says.
8. Be careful when planning for non-residents
When a non-resident of Canada dies, Mr. Trotta says, up to 25 per cent in withholding taxes apply to their RRSP, although there may be treaty relief depending on where the person was resident. There are also complexities related to having a non-resident as the beneficiary of an RRSP, as different rules govern the proceeds of trusts or estates going to non-residents.
“It’s very important to sit down with a qualified lawyer and accountant to make sure [clients] are mapping it out properly,” Mr. Trotta says. “A lot of mistakes can happen … where a financial advisor thinks it’s a really good idea to do X, and a lawyer thinks it’s a good idea to do Y, and then as a result, neither happens.”
Lawyers may be expensive, but it can be “a drop in the bucket” compared with tax or estate litigation, he says. “And with litigation, we lose control of the situation.”
