When opening certain investment accounts, investors may have the option to designate a beneficiary. It is important to consider the implications in order to minimize tax payable and ensure estate wishes are fulfilled upon the death of an account holder.
Registered Retirement Savings Plans (RRSPs) and other registered retirement accounts, like Registered Retirement Income Funds (RRIFs) and Defined Contribution Pension Plans (DCPPs), can have beneficiaries named to receive the account proceeds upon an account holder’s death.
The most common beneficiary is a spouse or common-law partner. The beneficiary can have the tax-deferred funds remain tax sheltered by transferring them to their own registered account. Even if the spouse is not named as the account beneficiary, there may be other methods to have the account proceeds transferred on a tax-sheltered basis to the surviving spouse.
Some wills specifically address RRSP accounts. If a will states that a spouse is entitled to amounts from an RRSP, the spouse and the executor (who is often the spouse as well) can elect to transfer the account of the deceased on a tax-deferred basis. Alternatively, if the RRSP is not addressed in the will, but the surviving spouse is a beneficiary, as is often the case, it is possible to make the same tax-deferral election.
If children or other non-spouse beneficiaries are named in an RRSP contract, tax is generally payable by the estate of the deceased on the market value of the account at the time of death. There may be exceptions for dependent children or grandchildren, allowing tax-deferral using a term-certain annuity to age 18, or for disabled children or grandchildren, by way of a transfer to their RRSP or Registered Disability Savings Plan (RDSP).
There are benefits to naming individuals as beneficiaries for an RRSP account. In particular, the account will be distributed relatively quickly following death, and without incurring probate fees or estate administration tax.
There are drawbacks, however. Naming an individual does not allow for contingencies that can be addressed in a will by naming your estate as beneficiary, like having a child’s share of your RRSP go to their children (your grandchildren) if the child dies before you or at the same time as you. This may seem unlikely, or you may think you can simply update your beneficiaries if this happens—but what if you become incapacitated as you age and you are no longer able to update your beneficiary designations? Someone acting as power of attorney cannot change testamentary wishes like beneficiary designations or your will.
A tax-free savings account (TFSA) can have a beneficiary or a successor holder. Only a spouse can be a successor holder. The benefit of naming a spouse as a successor holder is that they can take over a TFSA account upon the death of their spouse without impacting their own TFSA room or without any potential tax payable.
If a spouse is named as a beneficiary, a TFSA can be rolled into the survivor’s own TFSA without impacting their TFSA room by December 31 of the year following death. However, the exempt contributions are only up to the fair market value of the TFSA account at the time of death, and any subsequent income and growth is taxable up until the date of transfer.
A non-spouse beneficiary who is named for a TFSA will receive their inheritance relatively efficiently after providing a copy of a death certificate to the financial institution. Income earned after the date of death is taxable to the recipient and can only be transferred into their own TFSA to the extent that they have TFSA room.
Naming a TFSA beneficiary as one’s estate means that an account will be distributed based on the terms of a will. The TFSA proceeds are tax free to the estate, but subsequent growth after the date of death is subject to tax.
Registered Education Savings Plans (RESPs) are established for a beneficiary or beneficiaries to save for their post-secondary education. It should be noted, however, that an RESP beneficiary does not become the account beneficiary upon death. An RESP account is the property of a subscriber who opens and owns an RESP.
Some institutions allow joint subscribers, or the appointment of a successor subscriber, so that someone can take over an RESP account on the death of a subscriber.
You can also include a clause in your will to appoint a successor subscriber to administer an RESP account upon your death.
Failing to have a joint subscriber or naming a successor subscriber risks an RESP account becoming taxable, triggering repayment of government grants, and being subject to probate fees.
Non-registered investment accounts do not generally have beneficiaries, but may pass directly to a joint account holder or otherwise be dealt with in a will. Capital gains tax may only be deferred if the account passes to a spouse.
There may be exceptions for informal or formal trust accounts which, by their nature, are established for beneficiaries and held by a trustee. If a trustee dies, the trust does not necessarily come to an end, and may continue with other existing trustees or a replacement trustee. Likewise, the beneficiary may not immediately receive the account proceeds, which may continue to be held in trust until they attain the age of majority, or based on the terms of the trust deed.
Insurance companies offer Guaranteed Interest Annuities (GIAs) that are like traditional Guaranteed Investment Certificates (GICs), but are structured as life insurance contracts. As a result, they can have beneficiaries who receive account proceeds quickly and efficiently on death, avoiding estate administration and probate fees in the process.
Beneficiary designations may seem relatively straightforward—and they are, in many cases. Regardless, it helps to know the implications and alternatives in order to ensure your estate wishes are carried out properly.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
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