How would you like it if a parent left the majority of a $1-million estate to strangers he or she had never met and never intended to give a penny to? Sadly, it has happened before, and all that was needed to avoid this disastrous situation was a few minutes spent updating a beneficiary designation. “An ounce of prevention,” as they say.
Since it’s RRSP season, I'll focus on registered retirement savings plan beneficiary designations, but the same line of thinking holds true for life insurance policies, tax-free savings accounts, registered retirement income funds and other financial products.
When you die, the taxman treats the fair market value of your RRSP as income, which is subject to tax at your marginal tax rate. That means that if you have $200,000 in your RRSP, you can expect a tax bill of between $60,000 and $100,000 depending on how much other income you have that year and the province in which you reside.
You can avoid that tax bill if you pick the right beneficiary. Certain beneficiaries, known as qualified beneficiaries, will be able to receive the funds from your RRSP without anyone paying tax upon your death.
However, consider this scenario: You've left your $200,000 RRSP to your adult son and your $200,000 estate to your adult daughter, with the assumption that on a pre-tax amount, those two parts would be equal.
Since your son is not a qualified beneficiary, but a beneficiary nonetheless, he will receive the $200,000. The rest of the estate picks up the tax bill, however. That means that your daughter could be receiving only $100,000, since the taxes owing are paid by the estate before the daughter receives what is left over. That can make the next family get-together awkward at best.
One of the worst horror stories I've come across was a situation where a man died with a $3-million estate. He had remarried and had three kids. His first wife also remarried and had a child. Both his first wife and second wife predeceased him, and to make a long story short, after a lengthy legal battle, the first wife's child (who didn't know the man from Adam) ended up with the bulk of the estate while the man's own children ended up with about $30,000 to split among the three of them. The mix-up was caused by stale and conflicting beneficiary designations.
The moral of the story: Get your beneficiary designations up to date and make sure what is in your will matches everything else. Life will be much easier for those you leave behind if all your ducks are in a row.
Having a qualified beneficiary for your RRSP means you can avoid a big tax bill on the value of your RRSP when you die.
Who is a qualified beneficiary?
Financially dependent child or grandchild who is dependent because of a physical or mental infirmity
Financially dependent child or grandchild under the age of 18
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Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com.