Beneficiary – Page 2 – Doug Carroll

Estate as the designated beneficiary – An estate-planning lawyer’s perspective

“Make sure to designate a beneficiary on RRSPs, RRIFs and TFSAs so the money doesn’t fall into the estate.”

It’s such familiar guidance in investment and financial planning that it would be foolish to suggest otherwise. Or would it?

I recently had an exchange with a financial advisor whose client’s lawyer recommended the estate as the named beneficiary. It was a young family with a single child and nothing else remarkable.

Unusual though that recommendation may appear, I myself offered the same advice to some of my clients in my past estate-planning law practice. Then as now, beneficiary designations help bypass probate tax and estate creditors, but may be cast in a different light when considering the following countervailing points. [See Callout Box on Quebec below]

Tax onus on registered retirement savings plans (RRSPs)/registered retirement income funds (RRIFs)

A person named directly as beneficiary is entitled to the gross value of an RRSP/RRIF, with the tax liability falling to the estate. Though the named beneficiary has a joint liability under the Income Tax Act (Canada) for the proportionate amount of the estate’s tax, the Canada Revenue Agency would likely only bother pursuing such a course if the estate is insolvent. There is no provision for the estate itself to claim contribution from the RRSP/RRIF beneficiary.

This would not be an issue where the beneficiary/ies of the RRSP/RRIF and the estate are identical, but could be a serious concern in a situation such as a second marriage, whether on first or second death of spouses.

Flexible spousal rollovers

It may be desirable to have RRSP/RRIF proceeds come into an estate in order to take advantage of a deceased’s graduated tax brackets, rather than have an immediate rollover to a spouse. This could be particularly effective if the death occurs early in the year (i.e., there is little other income). Otherwise, the RRSP/RRIF simply adds on to the surviving spouse’s own registered funds, with potentially higher future tax cost to fully deplete (whether in life or at death).

Generally, the estate and surviving spouse can still elect to roll the excess (not included in the estate) to the spouse.

Amending and revoking

The Will gathers all beneficiary designations together in one place, centralizing control through that one instrument. Otherwise, the person would have to deal with the administrative rules, paperwork and potential delays in dealing with each financial institution. It remains that person’s prerogative to amend/revoke the Will, with the requirements of testamentary capacity being the same for a Will as for beneficiary designations.

On divorce (though not necessarily on separation), spouse entitlements in a Will are generally revoked (although this may vary by province) without having to execute a new Will. On the other hand, designations with financial institutions are not automatically revoked, even in the face of apparent explicit terms in an executed separation agreement. In fact, there is plenty of case law where this has been fought. (Even so, one should be tactful if raising this point with spouse-clients who are otherwise presently in wedded bliss.)

Inheritance contingencies

Trust terms in a Will can be tailored for later issue/grandchildren, whether as additions to the distribution or as stand-ins for one or more predeceasing directly named beneficiaries. For beneficiary designations, the default is generally that if AB, CD and EF are RRSP/RRIF beneficiaries and AB predeceases, CD and EF share equally under survivorship. That may not be the satisfactory expected result if AB has children whom the deceased would have wished to include.

If a target beneficiary has creditor and or matrimonial concerns (presently or as caution against future developments), trust terms may be attached to insulate against that exposure.

For spendthrift concerns (e.g., gambling, drinking, profligate), trust terms could be laid out, maybe to establish a short- or long-term allowance rather than a lump sum.

Transfers to minor beneficiaries or disabled beneficiaries will likely not be adequate as direct beneficiary entitlements, and may be detrimental in terms of impairing provincial support amounts (for the disabled), limiting investment options (requiring an annuity to age 18 for minors), losing control of distributed monies, and likely requiring consultation/approval of government authorities.

Estate liquidity

Absent cash in the estate (e.g., it consists solely of a house and other non-monetary assets), it may require someone to post the funds for the probate tax (to be eventually reimbursed) in order for the executor to take control of the estate assets and begin realizing on them.

Inter vivos or testamentary trust?

As a final thought, an estate is a testamentary trust that is taxed using graduated brackets. Assuming a principal beneficiary (e.g., a surviving spouse) is at a higher bracket than the estate, the cost of probate may be effectively negated by lower taxes on income generated from estate investments. In the past, this could potentially be carried on for many years, but after 2015 will generally only be available for the first 36 months of the estate.

Another alternative may be to have designations directed to a trust that is separate from the estate, with the result that probate and creditor concerns may be circumvented. The lost use of the estate’s graduated brackets should be factored into this latter approach, perhaps by directing some of the RRSP/RRIF proceeds to the estate or by providing the trustee with power to disclaim entitlement to some extent, in order to allow such RRSP/RRIF funds to fall into the estate.

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Callout Box – Quebec residents

Based on a Supreme Court of Canada ruling in 2004, financial institutions generally will not accept beneficiary designations by Quebec resident annuitants, forcing such registered plan proceeds to fall into the deceased’s estate. While a Will is a key planning tool for all Canadians, the mandatory involvement of the estate for registered plans in Quebec reinforces this need, and underlines the considerations expressed in this article.

Application of the two witness rule for Wills

At issue

Having two witnesses to a testator’s signature is an important component of the execution process for a person’s Will. In particular, the presence of witnesses provides a level of comfort that assists in dispelling concerns about potential coercion, undue influence or outright fraud, though it is certainly not a guarantee against those concerns.

On the other hand, where this witnessing requirement is not met, it does not necessarily mean that the Will is always invalid.

Wills Act 1837, (U.K.) 7 Will. 4 and I. Vict. C. 26, s. 9.

The source of the witness requirement in common law is the Wills Act 1837 from the United Kingdom. In the original incarnation (courtesy of Wikipedia), in addition to the testator’s own signature, section 9 requires that “the will is made or acknowledged in the presence of two or more witnesses, present at the same time; and each witness attests and signs, or acknowledges, his signature in the presence of the testator.”

Canadian common law provinces

Our common law provinces have legislative provisions similar to this UK law, but differ in their approaches.

‘Strict compliance’ with witnessing (and other execution requirements) remains the state of the law in Newfoundland and Labrador and Ontario (though see an exception below).

‘Substantial compliance’ may be sufficient in provinces where courts have been given power under legislation to admit a non-compliant Will that a judge is content reflects the testator’s wishes. These provinces are British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, Prince Edward Island and Nova Scotia.

Re Wozciechowiecz (1931 Alta. CA)

The testator signed the Will while in an ill state of health in bed. The first witness signed in front of the testator, but the second witness signed while at the foot of the bed outside of the testator’s field of vision. The execution was determined to be invalid as the testator could not see the second witness at the critical point of signature. Physical presence in the room was not sufficient.

In 2012, the Alberta Wills and Succession Act, SA 2010, c W-12.2 came into force, preserving the witnessing requirements. However, section 37 now allows a court to accept a Will that is not in compliance with execution requirements if there is clear and convincing evidence that it reflects the intentions of the testator.

Re Brown (1954 Ont. SC)

The testatrix executed the Will in the presence of one witness, and the two of them then moved to another room where a second witness was located. The testator and the first witness identified their signatures, and then the second witnessed signed.

The Will was found invalid as the witnesses had not been in the presence of the testator and one another when the testator signed.

Sisson v. Park Street Baptist Church [1998], 24 E.T.R. (2d) 18 (Gen. Div.) (Ontario)

In this case, the lawyer swore that he had prepared a Will in accordance with the written instructions of the deceased. The testator signed in front of the lawyer and his secretary as witnesses. The secretary signed as witness but the lawyer inadvertently did not sign.

In an unopposed court application, the judge confirmed that there was no substantial compliance provision in the Ontario legislation but felt that the court was entitled to develop the common law where there has been substantial compliance with the legislation. In the judge’s opinion, the dangers which the two witness requirement guarded against were not present, and thus the Will was admitted to probate.

Practice points

Though the executor may have broad authority pursuant to provincial law, this is not absolute in nature. There remain a number of obligations under common law that an executor must bear in mind when exercising the authority, the nuances of which can be discussed with a lawyer if problems appear to be arising:

One can see why lawyers can be sticklers about what may seem to be innocuous details, including who may be a witness, order and placement of signatures, concurrent physical presence and focused attention to the task.
Even in provinces with substantial compliance rules, it can still be uncertain (and costly) to have to make a formal court application to prove a non-compliant Will.
Though the exceptions are very rare, all may not be lost in provinces where strict compliance is the rule. Still, it would be best for the Will to have been carefully and properly executed in the first place, without need to resort to the court.

Non-spouse beneficiaries of registered plans – Form can affect tax incidence and entitlements

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.