Naming a Beneficiary for your RRSP: Avoid unnecessary tax

If you’ve set up an RRSP account you’ll know one of the standard questions on the application form will ask, "Who do you want to name as Beneficiary for this account?". If you opened the account a long time ago you may have forgotten who you originally named – it happens a lot actually: I’ve seen some accounts where the plan-holder’s brother, sister, mother or father is named as beneficiary – and you may want to review that decision, especially if you’ve since started your own family.

Writing-fortaxwriteoff.jpgThe Beneficiary is the person who will receive the value of your RRSP should you die. Unless you name a QUALIFIED BENEFICIARY, the full value of the RRSP is taxable as earned income on your terminal return.

This can have unintended consequences since the remaining estate will be responsible for the taxes while the full value of the RRSP will have been transferred to the beneficiary. With the estate owing the taxes, and if there were other beneficiaries of the remaining estate – the other beneficiaries’ share might be unintentionally reduced – leaving the estate unequally distributed after-tax.

On the other hand, by naming a qualified beneficiary to receive the value of the RRSP – the full value of the RRSP can be transferred without any taxes paid. Instead of the deceased plan holder including the RRSP income on the terminal tax return, the qualified beneficiary includes the RRSP income in their name – BUT also gets to claim an offsetting deduction for the same amount – hence, no tax is paid. One stipulation is that the actual transfer must occur BEFORE December 31st of the year FOLLOWING the death of the RRSP holder.

So to recap – you can avoid a massive tax bill by naming a qualified beneficiary. I should also point out that naming ANY beneficiary will avoid probate fees since the plan assets will pass outside of the estate upon death and directly to the beneficiary. (If you name the estate as beneficiary, then the RRSP assets will eventually have probate applied to them however.)

So who qualifies as a "qualified beneficiary"?

1. Spouse or Common-Law Spouse

2. Financially Dependent Child or Grandchild who is dependent because of a physical or mental infirmity

3. Financially Dependent Child or Grandchild under 18

All qualified beneficiaries except the financially dependent children under 18 (who are NOT dependent due to mental or physical infirmity) can choose to roll the plan assets into an RRSP, RRIF or life annuity. The financially dependent minor children or grandchildren who are not dependent due to infirmity only have the option of purchasing a Term Certain Annuity which must mature by age 18 (and all annuity payments are included as income until then).

Since an RRSP can have a value of $250,000 or more when a plan holder dies, it can generate a six-figure tax bill! So you can see, the beneficiary election is not something to take lightly at all as it can defer this big tax hit. If you haven’t updated your RRSP beneficiary (or reviewed it) lately, you might want to.

Also, whenever reviewing your estate and tax planning – you should seek the counsel of a qualified lawyer or accountant to help you figure out the nuances that pertain to your own situation. 

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Preet Banerjee
Preet Banerjee an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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