Advisors should make sure their clients have updated the beneficiary designations for their RRSPs and RRIFs, as well as their wills. Otherwise, advisors and their clients’ would-be beneficiaries could face some nasty surprises.

The main goal of naming a beneficiary is to ensure that the client’s assets go to the intended person or organization. And that they do so in the most tax-efficient, administratively simple way.

In the case of RRSPs and RRIFs, it is a matter of doing so on the application form. If the beneficiary is a spouse or a financially dependent child or grandchild, he or she will get a rollover under the Income Tax Act, so the RRSP or RRIF funds pass directly to the beneficiary. The funds do not go into the estate and taxes are deferred until the beneficiary brings the money into income. In such cases, probate fees are avoided.

If the beneficiary is an independent adult or a charity, however, funds from the RRSP or RRIF pass first into the estate, where they will be deemed a “disposition” and taxed, before reaching the beneficiary.

Couples, however, often make an incorrect and costly assumption, says Jack Courtney,
director of tax and estate planning at Winnipeg-based Investors Group Inc. They make “mirror wills,” leaving their entire estates to one another — including their RRSPs and RRIFs. They think that as long as they have designated the other spouse as the beneficiary in their wills, it is not necessary to designate the spouse on RRSP or RRIF application forms.

But, says Courtney, unless the designation is made on the RRSP or RRIF forms, the plan will be included in the estate’s assets, and probate taxes will be levied and deducted from the amount passed to the surviving spouse.

Divorce and remarriage generally have different implications for beneficiary designations
made in a will. In most provinces (Nova Scotia is an exception), divorce revokes any bequests to a ex-spouse made in a client’s will. But how divorce affects RRSP and RRIF designations made in a will is still not clear.

The question of whether revocation of bequests applies to beneficiary designations in a will has not been settled in the courts, says Barry Corbin, a Toronto sole practitioner specializing in trust and estates law. Therefore, the designation of an ex-spouse as an RRSP or RRIF beneficiary in a will may still be in effect — even though a couple is divorced.

Corbin says there are three sure ways for a client to revoke the beneficiary designations:
remarrying, which revokes any previous will (except in Quebec) and, therefore, the beneficiary designations; writing a new will; or destroying the old will.

“The general rule is that the last designation in time prevails, whether it is in a will or in a separate document,” Corbin says.

It is a good idea, therefore, to advise clients who are getting divorced to change the beneficiary designations both in their wills and on their RRSP or RRIF forms as soon as they are separated, says Courtney.

Making new designations may not preclude claims under provincial family law legislation, says Corbin. Some provinces will allow claims for “dependent’s relief” despite any changes made to the beneficiary designations.

With these various provincial laws in mind, a client who has moved provinces should be advised to ask a lawyer about the impact of the new province’s law on his or her beneficiary designations.

To claim the assets in an RRSP or RRIF, the beneficiary needs only to prove that he or she is the beneficiary and that the RRSP or RRIF owner has died (normally, with a copy of the death certificate).

If there are no other assets in the estate and the RRSP or RRIF assets pass directly to the beneficiaries, there may be no need to probate the will. This saves both legal fees and probate fees, which vary from province to province. In British Columbia, the probate fee is 1.4% on an estate of more than $50,000; in Ontario, it’s 1.5%, levied on the same basis. In most other provinces, the rate is about half as much; in Alberta, there is a flat rate of $400.

If there is no surviving spouse or dependent child and the RRSP or RRIF funds are passing to the next generation, the taxes will have to be paid by the estate. The deceased’s tax return will include the value of the RRSP or RRIF assets as income. “There will be a deemed disposition,” says Courtney — as if the assets have been sold, and thus any capital gains that have been earned will be taxed.

@page_break@“If a beneficiary has been named, the full value will pass to the beneficiary, minus the
taxes that must be paid by the estate,” he adds.

Sometimes, there will be a question of whether the estate can pay the taxes owed. “The [Canada Revenue Agency] will look to the estate first. Then it will look to the beneficiaries. The executor will have to collect.”

Often, says Heather Evans, partner and tax lawyer in the Toronto office of Deloitte & Touche LLP, parents want to equalize the value of the portions they pass to their children. For example, a mother with $1 million in assets names her adult daughter as the beneficiary of her $500,000 RRSP and leaves her adult son $500,000 cash.

The RRSP will pass to the daughter as beneficiary. However, the estate is responsible for taxes and, therefore, the assets inherited by the son will be eroded by probate fees and the income taxes triggered by the transfer of the RRSP.

“This happens more than you think,” says Evans, The estate is divided by a parent who is thinking on a pre-tax basis, she says: “But for every dollar of RRSP proceeds, the client must consider the tax implications — the post-tax calculations in equalizing the estate.”

When clients name more than two children as beneficiaries, they should also specify what will happen if one of their children predeceases them, says Corbin. Without clear instructions in the will, the deceased child’s portion would remain undisposed, and become part of the planholder’s residuary estate.

That law doesn’t apply to insurance-based RRSPs, says Corbin. Insurance legislation in the common-law provinces mandates that the deceased child’s share be reallocated among the surviving children.

Another option for a beneficiary designation, especially if there is no family to inherit your client’s RRSP or RRIF proceeds, is a charity. As with passing an RRSP or RRIF to an independent adult child, the deceased’s estate pays the income taxes. The upside for the estate is that it will be able to obtain a tax credit for a charitable donation of the donated after-tax amount.

Finally, advisors should be aware that failing to ensure their clients name beneficiaries on RRSPs and when they convert to a RRIF or an annuity may come back to haunt advisors in the form of liability lawsuits from angry people who feel they should be beneficiaries. IE