Designating a direct beneficiary on your RRSP or RRIF may make sense in some situations, however, there are cases when designating your estate is a better option.
People often designate a beneficiary on their RRSP or RRIF accounts, believing it is sound financial planning, since doing so can avoid probate and thus probate fees. However, this option may result in some negative consequences such as inequitable treatment of heirs, unintended elimination of heirs and unexpected tax consequences to the estate.
Taxation at death
If you designate a direct beneficiary to your RRSP or RRIF, then upon your death the entire value of your account will be paid directly to the named beneficiary, with no withholding for tax. However, the full value of the registered investment will be included in your tax return for the year of your death. Depending on who you designate, your estate could be responsible for paying the tax liability. Should your estate have insufficient funds to cover the taxes owing, the Canada Revenue Agency (CRA) can collect taxes owing from your direct beneficiary. Should your beneficiary be unaware of this potential tax liability, they could be in for an unpleasant surprise, especially if they have spent the money before being notified.
If your RRSP or RRIF is paid to a “Qualified Beneficiary”, a spouse, common law partner or financially dependent child or grandchild then the tax can be deferred, if your qualified beneficiary transfers it to their RRSP or RRIF. Different circumstances for children, but designating minor children is not typically advised.
Inequitable treatment of heirs due to tax
Let’s assume you have $50,000 in a RRIF and $50,000 in a TFSA. You name Child 1 beneficiary of your RRIF and Child 2 beneficiary of your TFSA. Upon your death, each child receives $50,000 – each account paid to each named beneficiary. Your estate has insufficient funds to pay the tax liability. CRA will collect taxes owing on your RRIF from Child 1, which will result in them receiving a smaller inheritance than their sibling.
Planning for a blended family
Do you have a blended family? You would like to provide an income for your surviving spouse for the remainder of their lifetime, but would like any remaining capital to go to your children. If you name your spouse as beneficiary, taking advantage of tax deferment, you lose the ability to impose any strings on that inheritance. Suppose your spouse remarries and designates their new spouse as beneficiary – it’s possible your children will never see any of their inheritance.
Use extreme caution when naming minor children as beneficiaries as well as naming too many beneficiaries. These too can have hidden consequences.
Designating a beneficiary should not be considered lightly. It’s quite common for individuals on their first marriage or common law relationship to designate their spouse. However, in other life situations things are not quite so simple. Speak to your Certified Financial Planner to ensure that your beneficiary designations are structured in a manner that best suits your needs.
This column is written by Michelle Weisheit CFP, IG Wealth Management and presents general information only and is not a solicitation to buy or sell any investments. Please contact your own advisor for specific advice about your situation.