A question that comes up regularly in class, and features much confusion, concerns RRSP beneficiary designations. I expect that most people are aware that an RRSP annuitant can name a spouse as beneficiary and achieve a rollover to the spouse’s RRSP on death. Similar rules apply to RRIFs. Common-law partners (12+ months of cohabitation or residing together and raising a child together) get the same treatment. The surviving spouse does not have to have any RRSP room to create this rollover.
A more complex set of scenarios involves the naming of children as beneficiaries on RRSPs. In some cases, a rollover may apply, but this is not a given. Outcomes vary depending on the exact circumstances.
In order to explore this, let’s look at the case of Tim. Tim is a recently single father of four children, and he is looking to change his beneficiary designation on his RRSP. He has an RRSP with a value of $80,000, and four kids:
- Natalie is age 24. She lives independent of Tim and earns a working income on her own. She has established her own life with the normal trappings of an independent adult.
- Carlee is age 21. She is living with Tim while she finishes her education, which is expected to take another 1-2 years. She earns $8,000/a working part-time.
- Paul is age 19. Paul qualifies for the disability tax credit. He works and earns $12,000/a at a part-time job. His income is supplemented by provincial disability supports, which provides him an additional $7,000 of annual income and valuable access to provincially-funded health care, including prescription drug coverage.
- David is age 16. He lives with Tim, and is not disabled. He does not have any sources of income.
Tim asks his advisor, Alex, about changing the beneficiary designation. Tim proposes that he name each child as a 25% beneficiary on the RRSP. Alex advises Tim of the following consequences, were he to die today:
- Natalie as beneficiary. The tax liability for Tim’s RRSP would be handled by the non-registered assets that would otherwise form part of his estate. If there were no other assets available, then Natalie would be liable for this tax liability. In either case, the tax liability is calculated based on Tim’s taxable income in the year of his death, which would include this portion of his RRSP. Any amounts that Natalie received this way would bypass probate.
Natalie would receive any funds into a non-registered account. The primary benefit of naming Natalie as beneficiary is the bypass of probate.
- Carlee as beneficiary. This is a slightly more complex scenario, and one where I find a lot of misunderstanding. Carlee, unlike Natalie, is dependent on Tim. For this purpose, dependent is defined in the Income Tax Act as having less than the combined total of last year’s Basic Exemption plus the Disability Tax Credit, if it applies. There is some question as to whether it’s required that Carlee live with Tim, or if dependency can be established via a question fact. Alex should seek professional tax advice in response to this question if, for example, Carlee has moved away to go to school, but still depends on Tim.
The basic personal amount from 2018 was $11,809, which is more than Carlee earned that year. As such, Tim can name her as beneficiary, and she can receive the funds on a rollover basis, meaning there is no tax liability for Tim, unlike if Natalie receives funds this way. CRA may even allow a waiver of this limitation, on a case-by-case basis.
This rollover provision does not remove the tax liability. It simply allows Tim’s executor and Carlee to determine who the best taxpayer to pay this tax is. If Carlee’s income is low in the year that Tim dies, and she is still dependent on Tim that year, she and Tim’s executor could elect to have Carlee pay the taxes. If it’s better for Tim to do so, then this would essentially be the same as naming Natalie as beneficiary, as above.
As above, naming Carlee as beneficiary has the primary benefit of allowing a choice of taxpayers to deal with Tim’s ultimate tax liability. She would receive the funds into a non-registered account and they would have bypassed probate.
- Paul as beneficiary. Because Paul is disabled, there are some special considerations here. First, his test for dependency uses the combined total of the disability tax credit ($8235 for 2018) and the aforementioned basic personal amount, for a total of $20,044. Paul’s income is less than that.
Because Paul’s income is less than $20,044, there are some additional outcomes available. If he has room in a Registered Disability Savings Plan (RDSP), then he or his guardian can, jointly with Paul’s executor, elect, within 6 months of Tim’s death, to roll funds into the RDSP. This rollover means there is no tax paid on Tim’s death, by either Paul or Tim. Any tax liability would be deferred until Paul makes withdrawals from the RDSP. No Canada Disability Savings Grants (CDSG) are payable related to this rollover.
If this is the primary source of funding of Paul’s RDSP, he can access funds in his RDSP with no concern about repaying prior CDSG or Canada Disability Savings Bond amounts, unlike a normal RDSP withdrawal. Holding funds in the RDSP means those funds are not subject to means-testing in the common-law provinces, so Tim’s provincial disability supports benefits would not be at risk.
It is also possible to use a Lifetime Benefits Trust (LBT) if Paul’s disability is due to mental impairment. The LBT would then purchase a term-certain annuity payable to Paul’s 90th birthday, with all payments taxable to Paul as ordinary income. Any amounts remaining in the annuity on Paul’s death can be paid to other beneficiaries, if named in the LBT when it’s set up.
Finally, it is possible for Paul to receive the funds directly into his own RRSP. This works essentially the same as a spousal rollover. Paul would hold the funds in a registered plan and would not need any contribution room. Any tax would be deferred until Paul made a withdrawal from his RRSP or RRIF. The biggest downside here is that this is likely considered an asset that might jeopardize Paul’s provincial disability supports. While the threshold varies by province, as little as $5000 of assets can cause Paul to fail the asset test and lose his benefits.
The primary benefit of naming Paul as a beneficiary is to create ongoing tax deferral, and allow Paul to have access to funds in his eventual retirement.
- David as beneficiary. Naming David as beneficiary creates a somewhat unusual outcome where the Income Tax Act does not match well with what is available in practice.
Many of you will be familiar with the provision in the ITA that allows David to receive these funds on a rollover basis. Under this provision, David would be compelled to purchase a term certain annuity, with the last payment payable in the year in which he turns 18. Assuming that he already celebrated his 16th birthday in the current year, this means that we would be able to spread the income out over 3 years.
For example, if he received $20,000, he would purchase a 3-year term certain annuity. At a 3% interest rate, this would result in annual payments of $7075. Those payments would be taxable to David as ordinary income. Effectively, Tim’s tax burden has been passed to his son, with an element of deferral.
However, provincial inheritance laws generally restrict minor children from receiving substantial gifts. Ontario and Alberta, for example, both place this prohibition at $10,000. If David would receive in excess of this amount, the Office of the Public Trustee (OPT) is likely to intercede. It is unlikely that the OPT would support the annuity described above. Generally, the OPT is more concerned with paying minimal amounts to a minor, and handing over the remaining principal at the age of majority. The OPT will generally not place any emphasis on tax planning. As such, Alex should consult a qualified estate lawyer before Tim makes this beneficiary designation.
If the annuity option is not selected, then the handling of a gift to David is the same as what was described for Carlee, above.
The primary benefit of naming David as beneficiary may be tax deferral.
The above circumstances would be essentially the same as with any registered plan, such as a RRIF or a pension.
As we can see, naming kids as beneficiaries of an RRSP can have benefits, but is also quite complicated. Depending on the dollar amounts in question, and the degree of tax and legal advice available, it may be preferable to simply name the estate as beneficiary and pay the taxes at death. I would suggest that the greatest benefits are likely to be associated with a disabled child who has reached adulthood.