RRSP Designation and Minor Beneficiaries
RRSP Taxation on Death
According to the Income Tax Act, the owner of an RRSP is deemed to have disposed of his or her RRSP on his or her death. Therefore, the value of an RRSP is included in the terminal year income of the deceased person and is fully taxable unless it qualifies for certain limited deferral options.
There are two basic deferral options. One deferral option is with respect to RRSPs where the beneficiary is the spouse (married or common law) of the deceased person. To defer tax, the surviving spouse who is a beneficiary of a RRSP can direct the RRSP proceeds to be transferred to his or her own RRSP. If this spousal rollover is utilized, the RRSP proceeds are taxed only when the proceeds are withdrawn by the surviving spouse from her or his RRSP.
The second deferral option is where the beneficiary of a RRSP is a financially dependent minor child or grandchild of the deceased. To utilize this deferral, the tax rules require that the RRSP proceeds payable to the financially dependent child be used to purchase an annuity with equal payments to the child continuing until the child reaches 18 years of age. The minor child’s RRSP benefits must be paid out in full to the child by the time the child reaches 18 years of age. Tax is payable by the child when he/she received the annuity payments.
RRSP Payments to Minors
Minor children are not entitled to receive funds directly. If a RRSP designation provides for a trustee to receive the funds while the beneficiary child is a minor, then the proceeds of the RRSP will be paid to the trustee in trust for the minor. This issue is often overlooked, because some RRSP forms allow for naming of trustees and some forms do not.
If no trustee is named on the RRSP designation, someone will have to apply to the court to be appointed to manage the child’s property. If nobody applies, the funds will be paid to the court and will be administered by the Accountant of the Superior of Court of Justice. The child’s parent or guardian is not automatically guardian of his/her property and is not entitled to receive the RRSP proceeds unless he/she is appointed to manage the child’s property.
If a trustee is named on the RRSP designation and no other trust terms are specified, the funds received by the trustee become subject to a bare trust, meaning that the trustee cannot pay out any amounts prior to the child becoming 18 years old and then the full amount held in trust must be paid out to child when he or she turns 18, and the trustee has no power to delay that distribution. Additionally, because the guardian of a child has the legal obligation to provide the necessities of life to that child, the child’s own assets, including the RRSP annuity payments described above cannot be used for this purpose, unless the guardian obtains permission from the Public Guardian’s office or the court.
Direct Designation on an RRSP
If a beneficiary has been named on the RRSP, the proceeds will be paid directly to the named beneficiaries upon death of the RRSP holder. Unless one of the above described deferrals are available, the value of the RRSP must be included in the terminal year income of the deceased person and the resulting tax will be paid out of the residue of the estate.
If the beneficiary of the RRSP is a different person then the beneficiary of the residue of the estate, then the beneficiary would receive the RRSP proceeds and the taxes would be paid out of the estate and reduce the amount available for distribution to the residuary beneficiaries. If the named beneficiary is an adult, the proceeds of the RRSP will be paid to them directly, with the tax burden being responsibility of the estate.
If a minor is named as a beneficiary of the RRSP, the proceeds will either be paid to the trustee, if one was named on the designation, or to a court-appointed guardian of the child’s property or to the Court. If the child beneficiary utilizes the above described tax deferral option, tax will be paid on the money received by the child pursuant to the required annuity payments. If the child does not utilize the annuity deferral, the estate will be obligated to pay tax arising in connection with the RRSP when the terminal tax return is due. Payments to any minor child will be subject to the rules described in the above section in regard to payments to minors.
As an alternative, rather than designating individual beneficiaries on an RRSP, an RRSP holder can designate his estate to be the beneficiary of the RRSP. In this case, the proceeds of the insurance policies will be paid to the estate. Tax on the RRSP will be paid with the terminal tax return of the deceased and the after tax net proceeds will become part of the deceased’s estate and will be distributed according to the terms of the Will of the deceased or pursuant to the intestacy distribution rules, which govern the order of distribution when a person dies without a Will.
In a Will, the deceased person can make various provisions as to how and when the RRSP proceeds are to be distributed to the minor beneficiaries. This is very useful if it is desirable to provide certain payments to a minor child prior to him or her reaching 18 years of age (i.e. education needs) and/or if it is desirable to postpone distribution for some period of time after the beneficiary turns 18.
RRSP Designations in a Will
Designation of beneficiaries of an RRSP can also be made in a Will. The beneficiaries can be individual beneficiaries or the estate of the deceased person and will effectively work in the same manner as designations made on an RRSP. However, a Will provides additional control and flexibility. The Will can be used to designate specific trustee, including substitute trustees, to hold any proceeds payable to a minor and trust provisions can be designed directing or permitting the trustee to make certain payments during the time the child is a minor, including provisions to whom such payments can be made on behalf of the child. Trust provisions can also be designed to require the trustee to delay distribution of the RRSP proceeds until the child reaches certain age above 18 years.
Other Considerations
There are various other considerations which should be taken into account when deciding how to set up RRSP beneficiary designations. For example, RRSP proceeds payable to the estate will become part of the deceased’s estate. This means they will be subject to claims by the creditors of the deceased. Whereas RRSP proceeds payable directly to the designated beneficiaries are not part of the deceased’s estate and, therefore, not (in most circumstances) subject to creditor claims. Also, proceeds of an RRSP which pass directly to a beneficiary and do not become part of the deceased’s estate do not trigger obligation to pay Estate Administration Tax (probate fee) on the value.
The purpose of this article is to provide the reader with general information and to encourage the reader to obtain specific and updated financial, tax and legal advice that applies to the reader’s situation. Nothing herein is intended to be legal, tax or financial advice. If you have specific legal questions please contact Adam Altmid.