RRSP and RRIF tax traps

The designation of beneficiaries is a very important component of estate planning especially when it comes to the RRSPs and RRIFs. It has been regular practice for financial advisors and institutions to list a beneficiary designation for the Registered Retirement Savings Plans (RRSP) or Registered Retirement Income Funds (RRIFs).

Related article: Designating Beneficiaries for RRSPs and RRIFs 

Generally it is common practice if you have a spouse to list your spouse as the beneficiary because the transfer will qualify for a tax deferred rollover to the spouse and there will be no tax paid. Remember that CRA will get their money later.

Tax TrapWith a RRIF only, if you are going to list your spouse as the beneficiary, you may want to designate your spouse as a successor annuitant instead. In this case, the spouse simply takes over from the deceased and continues to receive RRIF payments in his/her place. The investments in the RRIF are not affected by this, as there is no need to execute a new contract.

Watch beneficiaries other than the spouse

When someone other than the spouse is listed as the beneficiary, the RRSP/RRIF is deemed to have been sold just prior to death and the tax burden goes to the estate. Here’s a quick example of this:

Richard was in his second marriage and wanted to make sure that his 2 children, Beth and Art would get part of his estate. As a result, he listed his two kids as the beneficiary of his RRSP. His new spouse would get the house and his pension.

When Richard passed away, the kids got the RRSP money but the RRSPs were still taxable to the estate. When the final tax return was done, there was a significant tax bill but no money in the estate to pay it. The house and the pension did not go through the estate as it went directly to the spouse.

In the end, the kids had to pay the tax but the problem was they spent the money right away. The relationship with their mother-in-law was damaged for life because they felt that she should pay for part of the tax bill.

My two cents

There are a few possible solutions to prevent this trap from happening. The first is to simply watch the designation of beneficiaries on RRSPs and RRIFs. Just remember that no matter who gets the money, there will be tax that has to be paid.

Also remember the joke “Die broke and have fun at it”. The reason it’s a joke is because it’s really hard to do. That being said, when it comes to RRSPs, it’s best to have spent them before you die because they all become taxable when you die. The key is not to die with too much RRSPs but rather spend them while you are living.

Related article: Don’t Die with too much left in the RRSPs

And lastly, remember that life insurance can be a great estate planning tool because it creates liquidity. One of the benefits of having life insurance is it can create money in the estate to pay for the tax liability.

Related article:  The role of life insurance in estate planning

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace.For more information you can follow him on Twitter @JimYih or visit his other websites Group Benefits Online and Advisor Think Box.

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