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tax matters

I love the summer months. Sure, it's a time to enjoy some warmer weather, but it's also a good time to reflect on my estate planning. A lot of people don't like to think about the day when they won't be here any more. Woody Allen once said, "I'm not afraid of death; I just don't want to be there when it happens." The reality is, you've got to think about that day when you won't be here any more. If you don't, you could leave a mess for your heirs, and could pay a lot more to the taxman than necessary. Let me share a story that we can all learn from.

The story

John Arthur Murphy was a gentleman who unexpectedly passed away on Feb. 15, 2009 – without a will. He was survived by his spouse, Barbara DeMarsh, and his three grown children from his first marriage. Shortly after Mr. Murphy's death, the relationship between Ms. DeMarsh and the three Murphy children took a turn for the worse.

Since Mr. Murphy had died without a will, the Intestate Succession Act of Nova Scotia stepped in to dictate who got what. It's important to note the kids were named as beneficiaries on two of Mr. Murphy's registered retirement savings plans (RRSPs) with a total value of $392,236. The problem? Ms. DeMarsh wasn't happy with the outcome and filed an application in the Supreme Court of Nova Scotia under the Matrimonial Property Act where she sought to get a greater share of Mr. Murphy's estate.

Soon after, Ms. DeMarsh and the Murphy children came to an agreement that would see the proceeds of the two RRSPs transferred to an RRSP for Ms. DeMarsh in exchange for a cottage property in which she had an interest. The children and Ms. DeMarsh obtained a Consent Order that assigned the children's rights to the RRSP assets to Ms. DeMarsh in exchange for the cottage. The thought was that the RRSP assets transferred to Ms. DeMarsh should have been a tax-free transfer since she is his surviving spouse.

The law

When it comes to RRSPs owned at the time of death, our tax rules can be complicated. As a general rule, when the annuitant of an RRSP dies, he is deemed to have received the proceeds of the RRSP immediately prior to death and so the full value of the RRSP becomes taxable to him. But, if the RRSP proceeds are paid out to "certain beneficiaries," those proceeds are called a "refund of premiums" and the taxable amount of the RRSP is eliminated. The RRSP proceeds instead become taxable to the recipient. And that "certain beneficiary" can typically transfer the proceeds to his or her own RRSP and defer the tax until the amounts are withdrawn.

Those "certain beneficiaries" can be a spouse or common-law partner of the deceased annuitant, or a dependent child or grandchild. The question in the Murphy case was whether Ms. DeMarsh was a "certain beneficiary," which would allow for a transfer of the RRSP assets to her and avoid tax in the hands of Mr. Murphy in his year of death.

The decision

In the end, the court decided that there should be no tax-free transfer of the RRSP assets to Ms. DeMarsh. This seems to fly in the face of logic. After all, she was his wife and she ended up with the RRSP assets.

The judge, however, noted the beneficiaries of the RRSPs were the children – not his surviving spouse (and therefore the RRSP assets were taxable to Mr. Murphy in his year of death). He went on to say that the Consent Order did not change the beneficiaries in question, but rather simply conveyed the interests of the children in the RRSP to Ms. DeMarsh. In a different but similar case (Hillis v. MNR, 1983), the children disclaimed their interests and the assets became those of the widow. In the Murphy case, the kids did not disclaim their interest in the RRSPs. The result was a large tax bill paid to the Canada Revenue Agency.

The moral

If Mr. Murphy had taken the time to get his affairs in order, the strife between his kids and Ms. DeMarsh could have been avoided and the large tax bill paid to CRA would have been eliminated. The moral here? Get your estate planning in order. Have a will. Review the beneficiaries of your registered plans. Take taxes into account. Don't leave it to your heirs to figure out how to minimize tax and split your assets.

Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.

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