Lighten the Tax Load on Your Heirs

Your Registered Retirement Savings Plan (RRSP) poses the potential threat of a large tax liability, as well as probate fees, when you die. This can place a burden on your spouse or other heirs unless you carefully map out a plan to either minimize or defer taxes.

Here are some considerations:

If your RRSP isn’t paying retirement income when you die, Canada Revenue

Leaving a Mature RRSP If your RRSP has matured (in other words, it is paying retirement income), you are considered to have received the full fair market value of all remaining payments as income. That amount, along with any payments already made during the year, must be included on your final tax return after you die. However, the beneficiary won’t have to pay tax on an RRSP payment if it can reasonably be regarded as included in your income. If you name your spouse, common-law partner, financial dependent child or grandchild as sole beneficiary, the CRA allows the RRSP to be rolled over to them. The beneficiary simply becomes the successor annuitant and receives all future payments. But if you also name another beneficiary, the portion of the fair market value that doesn’t go to the qualified beneficiary must be included in the final return as taxable income. What if you don’t name an RRSP beneficiary in the contract? Your will plays a central role. The plan’s assets go to the estate. Your spouse, common-law partner, or financially dependent child or grandchild, along with the legal representative, can jointly choose in writing to be the successor annuitant. This is only the case, however, if your will states that one if these people is the heir or is entitled to the RRSP annuities. The CRA will then assume that the successor annuitant received the RRSP property and it will have to be included in income for the year it was received. Any post-death decreases in the value of an RRSP or Registered Retirement Income Fund can be carried back and deducted against the year of death inclusion.

Agency (CRA) considers that you received the entire fair market value of its assets on the date of your death. Thus, the value becomes taxable income on your final return.

What happens next depends entirely on how well you planned and who you named as the beneficiary in your RRSP contract. If you haven’t specified a beneficiary, your heirs may receive very little of the money. The after-tax funds become part of your estate, probate fees are assessed, and what’s left is distributed according to the terms of your will.

If you named a beneficiary, the person will receive all of the value of your RRSP. Probate fees are not assessed, but the income taxes are paid by the estate. This can result in an imbalance of the inheritance — with the heirs of the estate receiving very little after the taxes are paid, and the RRSP beneficiary receiving most of the value of the estate. (If the estate is unable to pay the taxes due on the RRSP at the date of death, the RRSP beneficiary is jointly liable for the taxes owed on the RRSP value.)

The good news is the Income Tax Act contains strategies that allow you either to defer or to minimize those taxes:

Tax Deferral: You can roll over your RRSP tax-free to a spouse or common law partner, or to a financially dependent child or grandchild. To the CRA, this rollover is the same as if that beneficiary had been the annuitant all along. So taxes aren’t due until that person actually withdraws money from the plan or from an annuity set up with the RRSP funds.

This strategy requires two basic steps:

1. In the RRSP contract, you must name the qualified individual as the sole beneficiary.
2. Before December 31 of the year of death, the beneficiary must arrange for the RRSP issuer to transfer the plan’s assets to an eligible RRSP, a Registered Retirement Income Fund (RRIF), or an annuity.
Warning: This tax-free rollover isn’t available if you named a beneficiary other than your spouse, common law partner, dependent child or grandchild, or you named more than one beneficiary.

Tax Minimization: Alternatively, your qualifying beneficiaries can qualify for special treatment by rolling the RRSP amount over into their own RRSPs — your income essentially becomes their income.

Amounts actually received by a qualifying beneficiary can be removed from your income and added to the beneficiary’s income. Then, the beneficiary can deduct the amount contributed to the RRSP, resulting in no taxes being paid. This allows the beneficiary to minimize the total taxes paid.

The beneficiary can transfer any amount of refunded premiums to an RRSP, RRIF or annuity, and claim a deduction to offset some or all of the refunded premiums included in income. This is not the same as a regular RRSP deduction because the beneficiary does not need RRSP contribution room, and the deduction does not use up any contribution room.

If you own an RRSP and are concerned about the taxes your heirs will pay after you die, consult with a professional to ensure you make the proper arrangements. And while you’re at it, make sure your named beneficiaries reflect any changes in your life circumstances to avoid any unwanted results.