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The long view

Pina Melchionna, of the Bank of Nova Scotia, says RRSP assets and beneficiaries should be specified in your will.



The long view

Your RRSP is a key part of your estate. Don't shortchange your beneficiaries by leaving them with a big tax bill

Diana McLaren

When it's RRSP time, most people view the benefits of tax deferral as immediate, but experts note that by taking the longer view and making it part of overall estate planning, the savings can continue after death.

"One of the basic tax rules is less is always more fun than more, and later is always better than sooner," says chartered accountant Sam Zuk, a partner at Soberman LLP in Toronto.

"If you designate your spouse or dependent child or grandchild under 18 as an RRSP beneficiary, the tax continues to be deferred on your death. The beneficiary continues to get the benefit of tax-deferred income and will pay tax when funds are withdrawn."

Given that retirement portfolios - whether RRSPs or registered retirement income funds (RRIFs) - are often one of the largest assets in many estates, it's a good idea to cover some of the basics where death and taxes are concerned.

Naming a beneficiary

"When a person dies, the RRSP [or RRIF] is deemed to have been cashed and is included in earned income," says Pina Melchionna, national director of will and estate planning for the Bank of Nova Scotia.

"This can result in a very large income-tax payment."

By naming a spouse or dependent child or grandchild (including those who are financially dependant adults with disabilities) as the beneficiary, the RRSP is essentially removed from your estate and transferred directly to the beneficiary with its tax-deferral status intact.

RRSP assets that remains in the estate as taxable income (that is, no beneficiary was named) need to be considered in the context of other holdings, says Mr. Zuk. "It's not just the RRSP - it's everything else, including investment and earned income as well as gains on capital assets. Even if your RRSPs are only $50,000, if that pushes your entire estate earnings in the year of death above $120,000, that excess portion will be taxed at the top rate of 46.41 per cent."

Probate savings

The other benefit from naming a spouse or dependent as beneficiary come from probate fees. For example, "in Ontario probate fees of 1.5 per cent apply on estates over $50,000," Mr. Zuk says.

"For someone who simply names their estate or some other person, not a spouse or dependent, as the RRSP beneficiary, this probate amount can be considerable. For example, with RRSPs of $600,000 the probate alone would be $9,000," he says.

Balancing interests

There may be times when paying the income or probate taxes are warranted if it fits within the overall intent of your estate planning.

For example, if you are in your second marriage but wish to leave RRSPs to adult children from a first marriage, "you might be prepared to have your estate pay the tax and/or probate on the RRSP to ensure the benefit goes where you intended it," Mr. Zuk says.

Unintended consequences

RRSP benefits need to be considered in light of your overall estate plan and what you intended for your beneficiaries.

"For example, if you wish to leave your entire estate in trust for an adult child, naming that child as beneficiary will have unintended consequences. They will receive the value of the RRSP outright, thus defeating any trusts you set up under your will," Ms. Melchionna says.

And splitting RRSP and other non-registered assets between beneficiaries can create differences you might not have intended.

As an example, she cites someone who leaves a $200,000 RRSP to one adult, non-dependent child and $200,000 worth of investments to another. When the person dies, she says, the value of the RRSP is taxable at the highest rate, with those taxes paid for by the estate.

"While the RRSP beneficiary gets the entire amount free and clear, that would leave the other child with considerably less of an inheritance," Ms. Melchionna says.

Be clear in your will

It's a good idea to spell out your RRSP assets and their beneficiaries in your will, says Ms. Melchionna. And it's important to review your will periodically to take into account any changes.

"If you prepare a will after designation of your RRSPs that makes some other statement [such as leaving your entire estate to some entity or an individual], that may revoke your prior RRSP designations. So you need to be clear about the intent of your will," she says.

Mr. Zuk also notes that care must be taken with spouses' wills and their ultimate beneficiaries. Assuming the first spouse to die leaves the RRSP to the other, "when both spouses are deceased, the proceeds come into the [beneficiaries'] income for tax," he says.

Depending on the size of the estate, this can result in the RRSP being taxed at the highest rate causing, what Mr. Zuk calls "serious depletion in the estate for surviving beneficiaries."

He notes that an insurance policy set up to pay the estate upon death of both spouses can generate tax-free income, which can then be used to pay the taxes due on the RRSP assets.

Creditor's claims

Legislation passed in July, 2008 made RRSPs held in banks exempt from seizure by creditors, except for the previous year's contributions. "If an individual goes bankrupt, the last 12 months' contribution is what can be seized by the trustee/creditors," says Mr. Zuk. (Previously this was the case only for insurance company RRSPs.)

Charitable gifts

RRSPs left as bequests to registered charities are exempt from taxes, so "this is a great way to reroute tax funds otherwise payable to the government to a worthy cause," Ms. Melchionna says.

Special to The Globe and Mail

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