How can my RRSP or TFSA impact my estate?

Intro Speaker:  

Hello, and welcome to Matters Beyond Wealth with your host, Leanne Kaufman, president and CEO of RBC Royal Trust. For most of us, talking about subjects like aging, late life, and estate planning isn’t easy. That’s why we’re going to help get the conversation started on this podcast while benefiting from the insights and expertise of some of the country’s top experts. We want to bring you information today that will help to protect you and your family in the future. Now, here’s your host, Leanne.

Leanne Kaufman:

RRSPs, RRIFs, RESPs, TFSAs, now FHSAs. These are all acronyms for the growing number of registered plans that the Government of Canada offers its taxpayers as tools to save. Save for education, save for a first home, save for retirement, or just save for a rainy day. Each of these plans comes with their own set of tax benefits, and knowing where to put precious earned savings can be complicated for those who aren’t comfortable with financial planning. They can get even more complicated though when you factor in how they impact your estate upon death.

Hello, I’m Leanne Kaufman, and welcome to RBC Wealth Management Canada’s Matters Beyond Wealth. With me today is my very learned colleague, Lorraine Allard, pension and institutional trust consultant at RBC Royal Trust. Lorraine is well-versed in advising on various retirement compensation arrangements and registered plans, and brings extensive legal expertise in pension and institutional trusts. Prior to joining us at RBC, Lorraine gained expansive knowledge in the area as a partner in the Toronto tax group of a major national law firm. Lorraine, thanks for being here with me today to discuss registered plans and estates and why this matters beyond wealth.

Lorraine Allard:

Well, thank you for having me.

Leanne Kaufman:

So, there’s so many different plans out there right now, as I listed off in my intro, which is great for us as taxpayers and as savers, but it can really lead to confusion in deciding which plans to focus on, especially if you don’t have funds for all of them at once. Let’s set aside the saving during our lifetime for a moment. Are they all treated differently on death when we’re talking about estates, or can we apply any broad brush commentary to what happens to these plans on death?

Lorraine Allard:

Well, the quick answer is that when anything that remains in the plan will go to the owner—and I use the term owner here because the act means the person having established the plan in different ways, so I’m just using a common term here—so, anything remaining in the plan will go to the owner’s estate, but of course, like French grammar, there’s exceptions to all of this. One of them is if you’re looking at a plan that contains government grants, those may go back to the government. And if we are talking about a plan where you can make a beneficiary designation, then the amounts remaining in the registered plan will go to the designated beneficiary instead of the estate. So that’s a very broad-brush kind of way to approach the topic. I like to use a rule of thumb in terms of taxation, which is if the contributions were deductible when made like an RRSP, that’s a good example, then whatever comes out of the plan, be it before or after death, will be taxable. In a plan where the contributions are not deductible, like an RESP or a TFSA, then whatever comes out the plan before or after death will generally not be taxable, except in some plans the income generated will be taxable. In an RESP, for example, the income generated will be taxable.

So, each plan is very different from that perspective, so it’s very difficult to speak in general terms really about the taxation of plans. You’d have to look at each one of them and the taxation of everybody involved in the plan, including the plan, depends very much on the type of plan that you’re looking at.

Leanne Kaufman:

So, you’re really going to want to get some advice at the time you’re thinking of setting these up about not only what it means during your lifetime, but what the impact would be to make sure you understand what’s going to happen.

Lorraine Allard:

Oh, for sure. Yeah, I think that’s a good rule of thumb.

Leanne Kaufman:

So, you mentioned beneficiary designations as being one of the areas where it could make a difference about the way the plan is treated or the assets in the plan are treated, and using beneficiary designations is quite a common and frankly, useful probate planning tool. Do all of the registered plans that are available to us as taxpayers in Canada have the opportunity to designate a beneficiary so that the assets don’t have to form part of the owner’s, as you said earlier, estate?

Lorraine Allard:

No, not all of them, but many of them. What I like to do is I like to think of registered plans in terms of buckets. So you’ve got the registered plans that are established by an employer for its employees. Those are the registered pension plans, deferred profit sharing plans. And then as you mentioned earlier, you’ve got all of these, what I call individual registered plans, or registered plans that are established by the owner. Those are RRSPs, RRIFs, TFSAs. RESPs or DSPs and the new FHSA, and sorry for using all these acronyms. For those who don’t know the FHSA, which is the new one, it’s the first home savings account.

So among those six plans, there are three that are sort of general application, the RRSP, the RRIF, and the TFSA. Basically, those are available to all taxpayers, basically. Whereas the RDSP, the RESP and the FHSA, those are of limited purpose. They’re not available to everyone. Right? The RESP will only come into play when somebody wants to open a plan to help fund someone’s education, for example.

Oh, and then the FHSA is only if you want to purchase or build a first home and that’s it, so those are very limited in their application.

Leanne Kaufman:

And those ones…none of those, RESP, RD— Disability Savings Plan—or FHSA have the ability to do a beneficiary designation?

Lorraine Allard:

Well, oddly enough in that bucket, the FHSA does allow for the designation of beneficiaries, but not the RESP and the RDSP. And I have to sort of put an aside to this. The Income Tax Act allows for designation beneficiaries, but until the provinces and the territories have amended their succession laws to allow for the designation beneficiaries and the naming of successors, there is no possibility of designated beneficiary for an FHSA, but there will be in the future. The same thing happened when TFSAs were introduced in 2009. Early on there was no ability to designate beneficiaries because each of the provinces and territories had to amend their legislation to allow for it. And another aside, when we talk about beneficiary designations, we’re talking of common law jurisdictions because that’s not really available in Quebec—so, for someone who’s subject to Quebec law.

Leanne Kaufman:

Right, so Quebec definitely needs to get different advice when it comes to all of these products. So I’m going to stick with beneficiary designations just for a minute. So, when I’m referring to beneficiary designations outside of the estate, I’m talking about ones where you can write down and designate the person that you want to receive it right in the account documentation when you’re setting it up with your financial institution, but I know that you can also designate beneficiaries for these plans in your Will. And then of course, if you don’t designate anybody, if you stay silent in the account documentation and in your Will, then I think it just falls into your estate. But we won’t go there just yet. So, any pitfalls when people start doing beneficiary designations in two different places, like they do some when they open their account documents with their financial institution and then they update their Will and they think maybe they need to address it there as well? What do you see as common pitfalls there?

Lorraine Allard:

Well, it’s a bit of a minefield, right? Because the financial institutions have designed designation forms that are part of the account documentation, as you’ve said, and those forms are designed to be as specific and as clear as possible as to the plan that’s being referenced and what is to become of the proceeds or the property in the plan following the owner’s death. Typically, at least among the RBC entities, we have two types of forms. A form for multiple primary beneficiaries, so I want to name my three children in equal shares, I’ll use that form, and it’s a two-to-three-page form. Like I said, everything’s in there, it’s very clear. There’s no mistaking what the intention is. The other type of form is one which allows the owner to designate one primary beneficiary and contingent beneficiary. So the contingent beneficiaries are named in case the primary beneficiary predeceases the owner. So, I’ll name my spouse as primary beneficiary and then I’ll name my children as contingent beneficiaries. So those are the forms that are available from the financial institution.

The problem in referencing a registered plan in the Will is that quite often—I see this fairly often—the designation is vague. So there’s all sorts of things in the Will, first of all, I have a designation in the document that is the Will, but the designation itself doesn’t form part of the terms of the Will. It’s like I took a designation, I stuck it at the end or the beginning of a Will.

That provision should be clear and say, “This is intended to be a designation as allowed under the Succession Law Reform Act of Ontario,” for example. Also, this is the gold standard. It should also say that it revokes any prior designations because in a Will, there’s sort of like a general revocation clause, but the legislation suggests that for the most part, most courts have said that that in itself may not be sufficient to revoke the designation, so the designation itself should revoke any earlier designation. And it should be as specific as possible so that there’s no confusion as to what RRSP or RRIF or TFSA the testator is referring to. And most of the escalations, because I deal with escalations that I see, are designations in Wills that are unclear as to the plan or as to whether there was a revocation of the early designation.

Leanne Kaufman:

As you said, a lot of minefields there to try to steer clear of. And again, it just continues to reinforce the importance of having some good advice around people who understand how all this plays out, and frankly, the importance of making sure that whoever you’re getting advice from understands your whole picture. Because changing your Will impacts the beneficiary designation and vice versa, right?

Lorraine Allard:

That’s correct. And when you go and see someone to draw up a Will, they should ask you and/or you should bring with you any copy of any designations that you have, first of all, because that individual needs to know what you own. It’s like any other property. You can’t deal with it properly in the Will if it’s not correctly identified.

Leanne Kaufman:

So let’s switch gears now and talk about tax for a minute, because this is another little minefield that maybe isn’t well understood if people haven’t got good advice on this when they did their planning. Can you tell us, and maybe we’ll just focus on the more common types of registered plans here, but in general terms, again, how are these plans treated from a tax perspective on death?

Lorraine Allard:

So, as I said, generally speaking, if the contributions were deductible, whatever comes out is going to be taxable. So let’s take the RRSP, which is the most common, probably still, registered plan, and probably for a lot of people, the most valuable. So the basic rule is that the Income Tax Act deems the deceased owner to have received the fair market value of the RRSP right before death. So that’s what the income tax pretends that the owner has received, the value of the RRSP, and so the estate is going to pay that tax unless there’s been a designation of a specific kind of beneficiary. And I should just back up.

If there’s any income that is generated in the RRSP after death, because it takes a while quite often for the issuer to get around to finding the beneficiary and paying out the proceeds, or to the estate, so there may be income that’s generated after death. That income will taxable to the estate or the designated individual. So that’s just a little aside. But basically, like I said, the Income Tax Act pretends that the owner of the RRSP took everything out of the RRSP before that. If, however, the owner had designated his or her spouse, then the tax burden is shifted to the beneficiary. So, all of a sudden, the act no longer pretends that the owner had received the fair market value and instead, the beneficiary will receive the funds, and in receiving the funds, will also receive the tax burden, so there’s no taxation of the owner or the estate in that case. The spouse and the dependent children are another category of beneficiaries where there’s the shifting of the tax burden. They’re sort of like privileged beneficiaries, if you will.

Leanne Kaufman:

You’re getting to defer that tax event.

Instead of it happening, so it waits until the death of the spouses or if there’s dependent beneficiaries.

Lorraine Allard:

Exactly.

Leanne Kaufman:

So it just puts off the inevitable a little bit longer.

Lorraine Allard:

Right. And in fact, that’s what an RRSP is. RRSP is a tax deferral mechanism. It’s not a tax-free mechanism. The tax will be paid eventually. But when I have a spouse, I can actually push all of that tax onto basically onto the second life.

Leanne Kaufman:

Right, and that would apply to a RRIF, an RRIF?

Lorraine Allard:

Right, because the RRIF is designed to be a successor to the RRSP, so I don’t contribute to a RRIF. What happens is the RRIF is there to receive proceeds from an RRSP, typically when someone reaches the maximum RRSP age of 71. Then instead of taking everything out of the RRSP, I can actually move all of the property or proceeds of the RRSP property into the RRIF.

Leanne Kaufman:

Just very quickly, TFSAs, because they’re the other really common one and broadly available. What happens to them on death?

Lorraine Allard:

Well, that’s different because in a TFSA, the contributions are not deductible. So rule of thumb, whatever comes out of the TFSA should not be taxable—generally speaking. Now, of course, there’s going to be income generated in the TFSA. Even that is not taxable. A TFSA, it’s the only registered plan that does truly constitute not just tax deferral, but tax savings basically. In a TFSA, I can also have designated beneficiary. I can have a successor holder just like I can for RRIF.  I can designate my spouse as a successor holder of the TFSA, and then my spouse becomes the owner of my TFSA.

Leanne Kaufman:

Yeah. Okay. My last question for you on tax and then I think we got to get out of the tax mire, but I think this is important. So sometimes people designate someone in their plan documentation, the account documentation where they open up the account with their financial institution. They designate someone there as beneficiary, but someone else inherits the residue of their estate. So you could have child number one getting the proceeds of the registered plan, and child number two getting whatever was in the taxable estate, not in a registered plan. Tell us about the tax implications to the beneficiaries when that happens.

Lorraine Allard:

Well ,the issue is that the ability to designate beneficiaries on registered plans means that those assets circumvent the estate altogether. They never fall into the estate. So, they’re not subject to probate tax for that reason. It’s a very beneficial treatment, basically. Now, if I’m leaving something to someone through a Will or if I don’t designate a beneficiary for a registered plan and the proceeds end up in the estate instead of circumventing the estate, then obviously those amounts are subject to probate tax, which means that the intended recipient will end up with probably less than the full value because probate tax will come off the top. So if I have $100,000 in a registered pension plan, I can leave $100,000 to the spouse, for example, but if what I do is the $100,000 ends up in the Will in the estate, then the estate tax comes off the top of that. So that’s why designating beneficiaries where possible is actually quite beneficial if it’s a simple designation, if I don’t have a very complicated list of beneficiaries that I had in mind.

Leanne Kaufman:

Right. And if it were one of the plans where the tax is payable by the estate or payable by the now deceased owner, that tax burden would be borne by the person who is the recipient of the residue of the estate, right?

Lorraine Allard:

Yes.

Leanne Kaufman:

So if you had $100,000 in RRIF and $100,000 in the estate account, the person who gets the RRIF is going to get $100,000.The estate has to pay the tax on the RRIF, so now they’re down to $75,000, call it—

Lorraine Allard:

Yes.

Leanne Kaufman:

And so now the person that gets the estate is only getting $75,000, because they had to pay the tax.

Lorraine Allard:

Yeah. That’s why designations are done so often, in part because first of all, they’re easy to do, and secondly, there’s a tax benefit too.

Leanne Kaufman:

Right, right. Okay. Well, Lorraine, thank you. It’s such a complicated area, and we could spend another half hour or hour, I think, going through all the details. But if you just wanted people to remember one thing in their mind about registered plans and the impact on their estate, what would that be?

Lorraine Allard:

Well, I think that quite often registered plans are a fairly valuable asset that people don’t really think much about. As I said earlier, when you have a Will drawn up, make sure that your lawyer knows what plans you have and what designations you’ve made and whether those designations are still what you intend, and refresh your designations just as you would with your Will on periodic basis to make sure that in fact, the way that I have the proper description, that this is what I intend still. Things evolve over time and I may have forgotten.

Leanne Kaufman:

Right. Remember who you named.

Lorraine Allard:

Exactly. So it’s important to keep them in mind like any other valuable property, basically.

Leanne Kaufman:

Well, thanks Lorraine, for joining me today to talk about all these different kinds of registered plans and the implications on your estate and why this matters beyond wealth.

Lorraine Allard:

Well, thank you.

Leanne Kaufman:

You can find out more about Lorraine at RBC Wealth Management’s website or on LinkedIn. And if you enjoyed this episode and you’d like to help support the podcast, please share it with others, post about it on social media, or leave a rating and review. Until next time, I’m Leanne Kaufman. Thank you for joining us.

Outro speaker:

Whether you are planning for your own estate, the needs of your family or business, or you are an executor for a loved one’s estate, we can help guide you, simplify the complex, and support your life’s vision. Partner with RBC Royal Trust and ensure your legacy will thrive for generations to come. Leave a legacy, not a burden™. Visit rbc.com/royaltrust.

Thank you for joining us on this episode of Matters Beyond Wealth. If you would like more information about RBC Royal Trust, please visit our website at rbc.com/royaltrust.