Estate planning and tax planning intersect in many ways. One of the places where this can have very significant property and tax implications is in the naming of non-spouse beneficiaries on registered plans, whether as contingents or simply in the absence of a spouse.
This can be relatively uncomplicated where spouses intend to transfer all their wealth to the survivor of them at first death, including full tax-deferred rollover of registered plans. Even after that event, things will often still be fairly straightforward, assuming an intended equal distribution among the mutual children through the survivor’s estate. (For the sake of discussion, let’s assume no minor children or disabilities to contend with, which would add many more wrinkles to the analysis.)
Commonly the children will be named as estate beneficiaries, with parallel beneficiary designations on registered plans. Generally this is premised on avoiding probate tax on the registered plan (in provinces where this is a concern), keeping it out of the reach of the deceased’s creditors, speeding the release of the proceeds, and perhaps reducing estate administration costs a bit.
While in most cases those beneficiary designations will indeed contribute to an efficient estate transfer, there may be situations where unexpected and undesirable results can arise. Here are some examples.
RRSP or RRIF beneficiaries
Suppose a son and daughter were named as beneficiaries of both the will/estate and a RRIF, but the son predeceases and had two sons himself.
Absent a detailed beneficiary designation with contingencies having been filed with and accepted by the financial institution, likely the full RRIF proceeds will go to the daughter. (Consider that the son and daughter were likely contingent on the original and possibly unchanged designation, so to go beyond that would have been a third stage designation.)
On the other hand, assuming the will had been drafted with the common phrasing used to pass inheritances down generations (“issue per stirpes”), the formal estate would be effectively split evenly between the daughter on one side and the two grandsons on the other. However, proceeds of the RRIF would have been brought into income in the deceased annuitant’s terminal year. (No rollover exceptions for spouse, minor child or disabled child apply here.) This is a debt to be borne by the estate, effectively half imposed on each of daughter and her two nephews.
Daughter could choose to compensate her nephews for the disproportionate results, but is not legally required to do so.
Beneficiary on pension
Compare the result if the parent’s plan was instead in the form of a registered pension plan. Unlike the inclusion of RRSP/RRIF proceeds in the deceased’s terminal income, a lump sum payment from a pension is generally taxable to the named beneficiary.
Assuming again a simple beneficiary designation where daughter was the only living beneficiary, the administrator would have paid to her the plan proceeds, net of withholding tax. She would then have to report the proceeds as her own income, and reconcile any remaining tax. Thus, while the grandsons may be shut out of this entitlement (at least initially, subject to their aunt’s inclination), they will not bear any of the tax liability.
As an aside, at a 2012 tax conference, the Canada Revenue Agency was asked whether pension proceeds paid to a named beneficiary at death could be reported and taxed to the estate as a ‘right or thing’. The CRA acknowledged that there is a very narrow exception, but it did not apply in the particular circumstances.
Estate as beneficiary?
It’s not hard to imagine things getting much more challenging where there are minors, disabilities, second marriages and blended families. Though it may seem a bit unconventional, much of the foregoing concerns may be alleviated by naming the estate as beneficiary of the registered plan, coordinated with a properly drafted will.
Depending on comparative tax positions of the estate and beneficiaries, this could mean more or less tax to be paid. And of course, probate tax and other estate implications result.
Still, as estate planning is at its core about taking care of the people who survive the deceased person, this may be a small price to pay (literally) to achieve a much greater degree of certainty.