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Whom should you designate as Beneficiary (Estate/Children) for your Retirement and Tax Free Savings Account, if you are a surviving spouse?


January 26th. 2015

Lately we have received a number of queries from surviving spouses for guidance in determining the beneficiary (estate/kids/grandkids) for their RRSP/RRIF/TFSAs.  The following analysis will provide some assistance in understanding the tax implications in various situations.

 

Registered Retirement Savings Plan/ Registered Retirement Income Fund (RRSPs/RRIFs):

 

Designating Estate as the Beneficiary:

If a taxpayer decides to designate his/her estate as a beneficiary, the RRSP/RRIF will become an asset of the estate and will be subject to probate fees.  There have been some recent changes in probate taxes in Ontario, so we advise to please consult your lawyer for the rates applicable to your situation. After paying relevant Estate taxes and Probate fees, the remaining estate will be distributed as guided by the instructions in the will.

 

Designating Children as beneficiaries:

In case of designating children as the beneficiary, there will not be any probate fees on this RRSP/RRIF, since it will be directly transferred to the designated children. The designated beneficiary will get the RRSP/RRIF at the Fair Market Value (FMV) on the date of taxpayer’s death. In this scenario, taxpayer should ensure that the estate (upon death) will have enough liquid assets to pay the taxes on the Fair Market Value (FMV) of the RRSP/RRIF as well.

 

If taxpayer thinks that he/she would have sufficient cash other than RRSP/ RRIFs to cover the tax liabilities on his/her final tax returns, then it might be okay to designate beneficiaries as it will avoid the probate fees. It is important to note that it is the residual heirs under the will who will bear the income tax cost of the RRSP/RRIF, while the designated children will receive the funds.

 

In both the scenarios, taxpayer would be taxed on his/her final tax return (upon death) at the Fair Market Value (FMV) of the RRSP/RRIF, however the differences will be in probate fees & liquid cash to the taxes related to RRSP/RRIF.

 

Tax Free Savings Accounts (TFSAs):

If the taxpayer does not have a surviving spouse, a TFSA holder may plan to designate a beneficiary for the account or have the account form part of their estate.

 

TFSA with designated beneficiary:

Where there is no successor holder (spouse/common-law), the TFSA contract may provide for a designated beneficiary or beneficiaries. The person so designated by the TFSA is deemed to have acquired their interest in the TFSA at the time of death for a cost amount equal to its fair market value at that time.

In essence, the fair market value at the date of death may be viewed as a non-taxable capital receipt to the designated beneficiary and may be withdrawn tax-free. Any increase in value after death will be subject to tax in the hands of the designated beneficiary. Since this designation does not preserve the tax-free status of the TFSA, other than for the income earned prior to taxpayer’s death, income earned in the TFSA after the date of death will be taxable to the beneficiary.

Designating the beneficiary will prevent the estate from paying probate fees on the value of the TFSA.

 

TFSA with Estate beneficiary:

Where the TFSA contract does not name a designated beneficiary, the property in the TFSA becomes an asset of the estate and is distributed in accordance with the terms of the deceased’s will.

Income and accrued capital gains in the TFSA to the date of death are exempt from income tax. The assets of the TFSA form part of the capital of the deceased’s estate and may be distributed to the beneficiaries in accordance with the terms of the will. Income accruing after the date of death, including capital gains or losses, is included in the taxable income of the estate and subject to income tax either in the estate return or the hands of the beneficiaries (if allocated to the beneficiary in the tax return of the estate). Probate fees will be payable on the FMV of the TFSA.

 

If a taxpayer thinks that he/she would have sufficient cash other than RRSP/ TFSA’s to cover the tax liabilities on the final tax returns, then it may be advisable to designate beneficiaries for these plans as it will avoid the probate fees. If a taxpayer decides to designate a beneficiary and there is a lot of tax payable in the T1 final return, this cash will not be available to pay the taxes as it will all flow through to the designated beneficiary.

 

On the basis of our analysis, you can see that the “right answer” depends on your specific situation.  There is no one answer to it, so we would advise you to discuss with your accountant before making any decisions.


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