Many folks obsess about saving and investing for their retirement but turn a blind eye to what happens when they die.
Thoughts about the end of life are unsettling, but owners of registered retirement savings plans (RRSPs) need to think ahead about how their cash will be doled out, or their beneficiaries could wind up with a big headache or a fat tax bill, financial advisers say.
"Estate planning isn't just for seniors," says Wilmot George, vice-president of tax, retirement and estate planning at Toronto-based CI Investments Inc. "Young people die, too. Death does not discriminate. If you know how registered retirement savings plans and registered retirement income funds [RRIFs] are taxed, you can plan around potential problems."
Naming a beneficiary from the get-go on an application form for tax-sheltered retirement savings plans is useful, especially if the owner has no will. Upon death, it keeps these assets free of probate fees and potentially complex estate settlements. If an RRSP or RRIF becomes tied up in an estate that can take months or years to settle, the proceeds won't be readily available to be distributed or to pay for funeral costs, said Mr. George.
Avoiding probate fees, however, should not be the priority at the expense of larger objectives, he cautioned.
"The beneficiary could be a spendthrift, or mentally or physically infirm, and can't manage money. It might make sense to name your estate the beneficiary, and leave detailed instructions in your will with respect to the distribution of those monies."
When naming a beneficiary for your plan and in a will, "you want to make sure they are consistent," he said. "If you have a conflict, very often what happens is that the later designation prevails. Sometimes that is what you want to do, but sometimes it is not."
Because RRSPs and RRIFs are deemed to be sold when someone dies, these assets could be taxed at the top marginal rates in the year of death, Mr. George said. A person's taxable income could include assets such as stocks and bonds held outside the retirement plan that will be deemed to be sold at death.
If a spouse or common-law partner is named the beneficiary, plan proceeds can be rolled over tax-free into their retirement plans, or in the case of a RRIF, the spouse can opt to continue receiving the RRIF payments. The tax-free rollover would also apply if the funds were bequeathed to a financially dependent infirm child or grandchild for their RRSP or their registered disability savings plan (RDSP).
Assets from an RRSP or RRIF can also be rolled over tax-free to financially dependent children or grandchildren who are minors, said Matthew Ardrey, vice-president of T.E. Wealth in Toronto. "I am divorced, so my children [ages 10 and under] are the beneficiaries," said the fee-only financial planner. "My RRSP would be split among them."
To reduce taxes, the proceeds from an RRSP could be used to purchase an annuity for each child with payments made to each until age 18. The money then would be split over a number of years and be taxable to each child instead of distributed as a lump sum that would be taxed heavily, Mr. Ardrey said. "They [children] could have little to no taxes payable at all on that RRSP money."
It is also possible for a charity to be named as the beneficiary of an RRSP or RRIF, except in Quebec where it must be a person.
For instance, a single adult with no children might want to give more money to a charity than the tax man, Mr. Ardrey said. The charitable tax credit, which can be claimed to offset the tax burden on the estate, rises to 100 per cent of net income in the year of death, compared with 75 per cent while the donor is alive.
RRSP or RRIF holders need to remember to update beneficiary designations when they experience a life-changing event such as a marriage or divorce, says Jim Yih, an Edmonton-based fee-only financial planner. Group RRSPs at the workplace are often neglected, said Mr. Yih, who also runs a personal finance blog called retirehappy.ca.
"We have seen situations where people, when they first sign up for a group RRSP plan, weren't married so they listed their parents [as beneficiaries]. Then, they got married and never changed it."
He recounted a similar situation in which a male employee, who had listed his wife as his beneficiary on his group RRSP, later divorced and was living common law with another woman. When he died, "because he had never changed his beneficiary for that RRSP [and he did not have a will], it was actually the ex-wife who got the money," said Mr. Yih. "He had been with the company for 10 years, so [the assets] were substantial."
The common-law partner said "it wasn't fair," but the only thing the insurance company could do was to pay the proper beneficiary, he said.
Many retirees don't want to withdraw from their RRSPs right away to avoid government withholding and income taxes, or because they have cash coming in from other sources such as a company pension, Mr. Yih said. But they should consider a strategy to withdraw [some cash from the RRSP as soon as they retire] or convert it to a RRIF earlier than the mandatory age of 71, he suggested.
For retirees, who typically are in a lower marginal tax bracket, "it makes sense to take little bits and pieces out to spread the tax liability over a longer period of time," he said. "Spend it. Enjoy it. Use it for a holiday.
"It actually may be a more advantageous tax strategy than not taking money out, and leaving a big chunk at the end when you die," he said. "The tax [hit] can be pretty significant if you haven't spent your RRSPs."