Choosing a beneficiary of an RRSP needs to be done with care

There are two important things to consider when designating a beneficiary for your Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF).

One is how you designate them and the other is the tax implications at death.

The Alberta Trustee Act allows you to designate names in RRSP and RRIF contracts. You do not need to indicate them in your will. However, if your will names a different person than in the RRSP or RRIF contract, the will rules over the contract.

For an RRSP or RRIF issued by an insurance company, the Insurance Act rules that the funds go directly to the beneficiary and do not form part of the estate assets.

If they were issued by a financial institution other than an insurance company, then the funds form part of the estate.

This can lead to unfairness for the heirs. For example, the deceased has named child A to inherit a $100,000 RRSP issued by an insurance company and child B as the only one to inherit an estate which has a $100,000 bank account.

Child A will receive the $100,000 RRSP proceeds directly from the RRSP administrator without any withholding tax. Child B will receive the amount in the bank account, less funeral expenses and payment of the deceased’s debts and liabilities, which will include tax on the RRSP proceeds.

The testator may have thought both child A and B would be treated equally but that is not the case.

A possible solution would have been to name child A and child B equally to inherit the RRSP as well as the residue of the estate. This would have established an equal distribution.

Another would have been to name the estate as beneficiary.

At death, The Canadian Revenue Agency (CRA) considers the amount in your RRSP and RRIF as cashed out and taxes must be paid on this amount by your estate unless you designated these proceeds to a ‘qualified beneficiary’.

These are:-

  • Spouse (includes common-law partner) – proceeds can rollover into their RRSP’s and RRIF’s tax free.
  • Financially dependent child or grandchild under 18 years of age - tax free proceeds can be used to buy a term certain annuity up to age 18. The annuity revenue is taxed in the child’s hands.
  • Financially dependent mentally or physically handicapped child or grandchild of any age - tax free proceeds can rollover to an RSP or RRIF. The child will pay tax on withdrawals.

If you don't have one at all you can designate anyone, such as children, the estate or charities.

If you choose to leave your RRSP or RRIF to a charity, your estate will receive a tax credit for the full value of your account which can be applied to 100% of your income in the year of your death and the preceding year. This is an effective method of saving on taxes.

For example, let’s assume that your RRSP has a value of $100,000 at death and you left this account to ABC Charity. The charity will issue you a receipt for $100,000. In Alberta the top marginal tax bracket is 39%, which means that you will likely pay $39,000 in taxes to the government.

The tax receipt will create a non-refundable tax credit of $49,950 which will bring the taxes owing to zero. The additional credit of $10,950 ($49,950- $39,000) can reduce taxes owing on other income.

Re-visit RRSP and RRIF contracts and wills to determine if you have made good beneficiary choices. This is especially important when circumstances change, such as a death in the family, marriage or divorce.

Always consult your professional advisers for clarity.