The tax treatment of RRSPs upon death is similar to the basic scheme that applies to other assets when the owner dies: property is treated as if it has been sold — referred to as a “deemed disposition” for tax purposes. The plan’s market value is included in the owner’s final, or terminal, return and is taxed as regular income.

But a number of strategies can avoid or reduce taxes on this income, especially in cases in which family members are the beneficiaries. In those cases, those receiving the income can frequently benefit from rollover provisions, depending on the terms of the RRSP and of the will.

Take spouses, for example. Naming a spouse or common-law partner as the beneficiary of an RRSP allows the assets to be rolled into the surviving spouse’s existing plan. In this way, the assets go directly to the beneficiary and are not taxed, either in the estate or in the hands of the recipient, as long as they remain inside the plan.

If no beneficiary has been named, the assets in the RRSP fall within the deceased’s estate and will be taxable on the terminal return. Most tax experts suggest that annuitants make sure they list their spouse or common-law partner as the beneficiary of their RRSP.

Even if this has not been done, the money can be rolled over tax-free to the spouse or common-law partner. But in this situation, the terms of the will become crucial. “The estate is governed by the will,” says Jamie Golombek, vice president of tax and estate planning at AIM Funds Management Inc. in Toronto. “If the will says the surviving spouse gets all the assets, an election can be made between the executor of the estate and the surviving spouse to have the RRSP assets contributed to the surviving spouse’s RRSP on a tax-deferred basis.”

Minor children and grandchildren who are beneficiaries of RRSPs may also be able to take advantage of special tax rules upon the RRSP holder’s death. Although the funds will be taxable in their hands, even if they are financially dependent on the annuitant, they may use the proceeds of the plan to purchase an annuity. The term of the annuity must end by the time the child turns 18. “That strategy spreads the tax liability over a number of years,” Golombek says.

Rules for children and grandchildren are modified for those who are financially dependent on the annuitant because of a physical or mental infirmity: in that case, the RRSP can be directly rolled over without tax to the child or grandchild’s RRSP.

As with spouses, so with children: if there is no named beneficiary but the will directs the money to be left to the child or grandchild, an election can be made by the executor to have the money rolled over to the child or grandchild.

In the case of charities, the annuitant has the option of naming a registered organization as a beneficiary. The charity would get the funds from the RRSP. The estate is entitled to a tax credit from the charity, which can be used to reduce the tax liability created by the deemed disposition.

“Although you will have an income inclusion [of the market value of the RRSP in the deceased’s terminal return] you will also get a charitable donation deduction for a comparable amount,” says Gena Katz, executive director of tax practice at Ernst & Young LLP in Toronto. “So, effectively, you’re not taxed on it.”

If there is a named beneficiary, tax liabilities created by the deemed disposition will be paid by the estate. If the RRSP’s beneficiary is a financially independent adult child, that person will get the proceeds from the RRSP, but the estate will be left with the tax bill — a thorny issue if there are other siblings. To maintain fairness among beneficiaries, most tax experts suggest, if there are no beneficiaries entitled to special tax treatment, the RRSP should name the estate as beneficiary. Once in the estate, the RRSP’s proceeds can be divided according to the terms of the will.

Buying insurance is another way to deal with a steep tax bill. It can supplement the value of the estate or cover the tax anticipated from the RRSP’s deemed disposition. IE

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