Why nam­ing the wrong ben­e­fi­ciary on your RRSP can be costly

Tax im­pli­ca­tions are at the top of the list, writes Sab­rina DiFed­erico

The Hamilton Spectator - - BUSINESS - SAB­RINA DIFED­ERICO

Have you named the right ben­e­fi­ciary on your RRSP? For many peo­ple, the an­swer is no.

Some as­sets, such as life in­sur­ance poli­cies, seg­re­gated funds and Reg­is­tered Re­tire­ment Sav­ings Plans (RRSPs) can have ben­e­fi­cia­ries des­ig­nated di­rectly on the plan. This means that in the event of your death, these as­sets will pass di­rectly to the named ben­e­fi­ciary with­out flow­ing through your es­tate.

In gen­eral, it is a good idea to name ben­e­fi­cia­ries when pos­si­ble. There are nu­mer­ous rea­sons, but chief among them is that named ben­e­fi­cia­ries re­ceive the pro­ceeds much faster than if the as­sets must flow through the es­tate. This is es­pe­cially im­por­tant if the ben­e­fi­cia­ries need to cover fu­neral costs, lawyers, travel costs, etc. The other ad­van­tage is that the as­sets go di­rectly to the named ben­e­fi­cia­ries and don’t at­tract any es­tate ad­min­is­tra­tion tax.

So with all these ben­e­fits, why am I say­ing you’ve named the wrong ben­e­fi­ciary on your RRSP? It’s not that you shouldn’t name a ben­e­fi­ciary; in­stead, you should con­sider the in­come tax im­pli­ca­tions that may re­sult from your choice of ben­e­fi­ciary.

Money that goes into an RRSP is in­come tax-de­ferred: when you put money into the RRSP, you get a re­fund on the in­come tax you paid on those earn­ings.

On the flip side, when you take the money out, you must pay in­come tax on the funds you with­draw. In this way, you de­fer pay­ing in­come tax from your peak earn­ing years to your re­tire­ment when your in­come is lower. In the­ory, fol­low­ing this plan means you pay less in­come tax.

If you die be­fore you’ve had an op­por­tu­nity to with­draw all the funds from your RRSP, the money will pass on to your named ben­e­fi­cia­ries. If the ben­e­fi­ciary you name is your spouse, they will get the money as an RRSP. An RRSP gives them some flex­i­bil­ity to con­trol the with­drawal of funds and, in this way, man­age the in­come tax li­a­bil­ity.

But what if you name your adult, non-de­pen­dent son Joe as the ben­e­fi­ciary of your $100,000 RRSP? Joe will get a cheque for the full value of the RRSP. No tax? Lottery win, right? Nope.

You will be deemed to have with­drawn the funds from your RRSP, in full, at the mo­ment of your death. De­pend­ing on your in­come, your es­tate could owe as much as $50,000 in in­come tax.

Canada Rev­enue Agency will look to your es­tate to pay your in­come tax bill. Re­mem­ber that Joe al­ready got his money and it is not part of the es­tate.

Now let’s say you left your cot­tage to your adult daugh­ter, Mary, fig­ur­ing both the cot­tage and the RRSP were worth about $100,000. You may be sur­prised to learn that the es­tate might have to sell the cot­tage to pay your in­come tax bill. Mary will get what­ever is left, but it will be far less than Joe got.

If the RRSP was your only as­set, it ac­tu­ally gets worse in­stead of bet­ter. Since the RRSP went di­rectly to Joe and you have noth­ing else, your es­tate will have no cash with which to pay that tax bill. Seems OK, right?

Not re­ally. CRA will look first to the es­tate, then the es­tate ben­e­fi­cia­ries, then to your ex­ecu­tor, and even­tu­ally they will track down to whom the RRSP was paid.

The process won’t be in­stan­ta­neous. In fact, it might take a few years. Long enough that those funds are long spent and life has moved on.

But CRA will still come to Joe with your $50,000 tax bill and de­mand pay­ment.

Don’t let your legacy be a hid­den in­come tax bill. How can you avoid this? 1) If you are mar­ried, leave the RRSP to your spouse.

2) Warn your chil­dren in ad­vance to file your fi­nal tax re­turn be­fore spend­ing any of their in­her­i­tance.

3) Leave a por­tion of the RRSP, say 30 per cent, to the es­tate so you know there are some liq­uid funds in the es­tate to cover some, if not all, of the in­come tax.

The views and opin­ions ex­pressed in this ar­ti­cle are those of the au­thor, Sab­rina DiFed­erico, CFA, CPA, CA, MBA, an in­de­pen­dent fi­nan­cial ad­viser with her own wealth man­age­ment prac­tice in Hamil­ton. She can be reached at sab­[email protected]­aged­wealth.net. Ex­am­ples are for il­lus­tra­tive pur­poses only. Cal­cu­la­tions are based on a num­ber of sim­pli­fy­ing as­sump­tions. Seek pro­fes­sional ad­vice and con­sider your unique cir­cum­stances in es­tate plan­ning.

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