When it comes to RRSPs or RRIFs are you making these costly estate planning mistakes?

Leanne Kaufman:

So, you have spent years, even decades, building your retirement savings and carefully watching your RRSPs grow. But do you know what happens to those hard-earned dollars when you’re no longer here? The decisions you make today about your RRSP could mean the difference between leaving a legacy and leaving a tax burden for your loved ones. What many Canadians don’t realize is that without proper planning, a significant portion of your RRSP savings could end up going to taxes instead of your family, impacting the legacy that you wish to leave behind.

Hello, I’m Leanne Kaufman, and welcome to RBC Wealth Management Canada’s Matters Beyond Wealth. With me today is Ali Spinner, a partner in Crowe Soberman’s Tax Group. Her practice focuses on helping wealthy families, high-performance professionals, and entrepreneurs structure their affairs in a tax-efficient manner.

Ali, thanks for being here with me today to explore RRSPs with respect to estate planning and why this matters beyond wealth.

Ali Spinner:

Thank you so much. I’m excited to be here.

Leanne Kaufman:

Before we dive into too many of the details, can you help our listeners understand why RRSPs require special attention in estate planning compared to some of the other assets they may hold, and maybe more specifically, what makes them unique from both a tax and a legacy perspective?

Ali Spinner:

That’s a great question, Leanne. You’re absolutely right. With estate planning, RSPs have very special things that we have to consider from a tax point of view. The first thing that I want to mention so that the listener understands is that we’re talking about RSPs as well as RIFs. We know that once we turn 71 years old, an RSP has to be converted into an RRIF. So, I’m going to use the term interchangeably. I just wanted to set the stage.

So, the reason that we have to think about RSPs, especially from an estate planning concept, number one, what’s really important with RSPs is that when we pass away, unless we’re leaving the RSP to a surviving spouse, the value of the RSP at the time of death becomes fully taxable as regular income. What I find with many clients is that the value of assets left in an RSP at the time that they pass away can be the most taxed item that they have on their balance sheet, if you will. In Ontario, for example, the value that the RSP can be taxed at would be fifty-three and a half percent at marginal rates.

And I often see that perhaps different Canadians who maybe weren’t at the highest marginal rate throughout their lifetime, if their income per se wasn’t $250,000 and above, they often weren’t paying tax at the highest rates. But when they die, if the entire value of their RSP comes into their income, because they don’t have a surviving spouse to leave the RSP to, all of a sudden, they might find themselves in the highest tax bracket. I’ve had calls from clients asking me why their mothers, for example, or their fathers were paying so much tax on their RSP at death, when they were subject to much, much lower tax during their lifetime.

So that’s one key item that people have to consider. The other one that I want to mention, and this might get a little bit technical but I’ll try not to get too technical on you, is that when an RSP has a designated beneficiary, meaning that it goes directly to a certain individual when we pass away, whoever it might be. What’s interesting to note is that the value of the RRSP without the tax, the value of the RRSP goes directly to the person to whom we’ve left it to. But if there is tax as a result of not leaving the RRSP to a surviving spouse, the tax is actually borne by your estate, which is a different entity than the person to whom you’ve left the value of the RRSP. That can yield some funny results because you might have one group of beneficiaries paying the tax on the RRSP, while another beneficiary receives the RRSP proceeds. So, there might not be a matching.

Leanne Kaufman:

Yeah, it can lead to real inequities, and I think that’s why the planning is so important because, like you said, people don’t realize that. And going back to your first point, there’s a lot of people that don’t understand that that full value of the RRSP is considered taxable income in the year of death. So those are both really important points. Thank you for raising them.

You talked about naming a beneficiary or a designated beneficiary. Sometimes maybe people think that that’s all they need to do is to, that’s the only planning involved. Think about who that designated beneficiary is going to be, but you’ve already alluded to the fact that it’s not always that simple. What are some of the more common mistakes that you see Canadians are making when it comes to their RSPs or RIFs in their estate planning?

Ali Spinner:

Sure. One of the mistakes that I sometimes see is that the individual, when making a designated beneficiary, also has to communicate with their lawyer who’s drafting their Wills to make sure that their Willsand their designated beneficiary, it all works together and that it’s thoughtful and that one perhaps isn’t cancelling something else out.

But that’s for another podcast altogether. Some of the more common mistakes that I see from an accountant’s point of view is that I’ve seen times where an executor has simply forgotten to tell the accountant that the person who passed away had an RSP or a RIF in the first place and the accountant didn’t know. And what happened is the value of the RSP at death wasn’t included in the deceased’s return. Of course, the CRA will find you one day and there’s often a big surprise saying, oh, my goodness, how come there’s all this additional tax to pay? So, it’s very important to get that information to the accountant preparing the terminal return of the individual that passed away.

One other item that I see that people make mistakes with, in the sense of they have an RRSP, but they don’t realize or they do realize, but they don’t know what to do with it, meaning that they actually don’t need the RRSP to fund their income in retirement. And sometimes I’ll say it’s a bit of a wasted opportunity if they didn’t need the RRSP to fund their retirement, to perhaps use it to fund donations or other philanthropic planning that they had in their lifetime without thinking about the big picture with respect to estate planning.

And the last piece, this is a mistake that I’ve seen happen a number of times. It’s true, people do think that just because they’ve made the designation as part of their plan documents, that’s all they have to do. But there are some key things that absolutely have to happen after someone has passed away in order for the RSP to perhaps transfer on a tax-deferred basis into a spouse’s plan, and they are time-sensitive. And I’ve seen situations where people have received letters in the mail or communications from their financial institution asking for instructions as to where the RSP proceeds should go, and they’ve missed the point in time at which they could make it easy to have the amount transferred somewhere else. So, it’s not just enough to make the designation. The executor has to make sure after someone has passed away that if there is to be a tax-deferred rollover into someone else’s plan, that all timelines are adhered to.

Leanne Kaufman:

So, it’s not just an awareness of the rules for the client during their lifetime to do their planning, there’s also an awareness that executors need to have about things that might only be available to be done after the client has passed.

Ali Spinner:

Absolutely.

Leanne Kaufman:

Okay, so let’s talk a bit about some tax smart strategies. What are some of the options that Canadians have to minimize this tax impact that the RSP or RIF might haveon their estate? And does it depend on who the beneficiary might be?

Ali Spinner:

Sure, so it absolutely can depend on who the beneficiary is. If we have a situation, if we have two spouses who are both alive, and if their plan is to leave assets to each other first, and on the death of the second to die, to leave assets perhaps to the next generation, to the children. Then the likelihood is that the time at which the value of whatever is remaining in the RSP becomes taxable is going to be farther away from the point of view that we have to wait for both individuals to pass away, as I mentioned before, on death. If you’re leaving the RSP to your spouse, then that can happen without taxation.

But a really key planning point, and I bring this up over and over again in my practice, is that in our retirement years, when we are drawing money out of our RSPs or our RIFs to supplement our income, we all know that there’s a minimum amount that you have to start drawing out after the age of 71. But what I find we often forget is that just because it’s the minimum doesn’t mean it’s the only amount that we have to pull out from the RSP or the RIF. The reason why this is important is that we started off discussing how. For example, in Ontario, likely, if there’s a significant amount of wealth in your RRSP at death, that entire balance is going to be subject to tax at, let’s say, 53.5 percent. However, if you’re an individual or if you have a parent or a loved one who is drawing money out of their RRIF, but they’re not at the highest top marginal tax bracket, for example, around $250,000, there can absolutely be planning to pull out more than the minimum requirements from a registered retirement plan while you’re alive.

For example, if you can pull the money out, yes, you are absolutely prepaying tax. In this situation, you otherwise wouldn’t be paying the tax until you passed away. But if you can prepay the tax at such a low amount because you’re taking advantage of your low tax brackets, the delta between the prepayment of the tax and the tax that you would otherwise pay when you passed away can be very significant. What I often find is that if you’re a person and you’re below the old age security clawback limit, usually what I recommend is we increase your withdrawals out of the registered plan to bring you up to just underneath the old age security clawback limit.

Nobody likes to have to pay back their old age security. If you’re well above the limit and you still have some room in your marginal tax rates, you could also consider pulling out some excess funds from the registered account. But that is a plan that absolutely can save the individual and really their estate, assuming that they’re going to have assets left over when they pass away. This can save real dollars to the family overall, which goes back to the friend that called me up who said, why is my mom paying so much tax when during her lifetime she paid so little tax? And unfortunately, the answer there was, well, you could have been pulling out some excess funds over time to take advantage of lower marginal rates.

Leanne Kaufman:

It is funny, there’s kind of a psychology to it, isn’t there, that people don’t want to pay the extra tax today, they think the deferral is always better, but in this case, the deferral could mean the difference between top marginal rate and some other much lower rate.

Ali Spinner:

Absolutely, you’re absolutely right. It’s not intuitive, but when you start to work through the numbers, it makes a lot of sense.

There’s one more comment I just want to make about tax efficient strategies when working with an RSP or a RIF. This goes back to the person who determines in retirement that they actually don’t need the money that they’ve accumulated in their registered plan to live off of. Perhaps the money is extra, if you would say, with respect to what they need for living expenses.

What I’ve been seeing more and more so is that Canadians are using the amounts in their registered retirement plans to fund donations. And when that happens, something that Canadians should remember is that typically, if you’re making a withdrawal or an extra withdrawal, there’s going to be a withholding tax applied by the RSP financial institution that has the money. But if you file a form, it’s called a T1213, that’s the form that you would file with the Canada Revenue Agency. And you basically ask permission, you basically tell them that you’re going to be donating the withdrawal from your RSP. You’re able to get that form certified, filed by the Canada Revenue Agency. You can then provide it to the financial institution, and the good news is that the financial institution does not have to withhold any money from that withdrawal that’s going to be used for donation purposes. And hopefully, the planning would be that the donation tax credit that gets generated by making the donation offsets the amount of tax that would be paid on the withdrawal out of the RSP, subject, of course, to the 75 percent limitation, but again, for another podcast.

Leanne Kaufman:

Go get some personalized tax advice at that point.

Ali Spinner:

Of course.

Leanne Kaufman:

Let’s switch gears for a minute, and we’re still going to talk about RRSPs, but a lot of people also, of course, have built up significant wealth in the TFSAs now that they have if they’re able to fund both types of registered plans. So, can you just draw a distinction between how those two types of registered plans are treated when it comes to estates?

Ali Spinner:

Sure. So, on a TFSA, there is no tax at death.When the person passes away, if the funds are distributed out of the TFSA to the beneficiaries of the estate or directly to the estate, there would be no tax on that money. The TFSA is a tax-free savings account. So, that’s great news.

Of course, with an RSP, as we just discussed, with withdrawals, the withdrawals are taxable, as well, when we pass away, the balance in the account becomes fully taxable. So, there’s a very big distinction between the two accounts with respect to, well, what happens when I pass away.

Leanne Kaufman:

Do those differences influence the advice you would give about people in their overall estate planning strategies?

Ali Spinner:

I think the differences between the two accounts give rise to decisions about which bucket should house which asset, meaning what type of asset should I hold in an RSP versus what type of asset should I hold in a TFSA? For example, in an RSP, because all amounts of withdrawals come out as regular income, it has the downside, if you will, the downside effect of converting capital gains or dividends that might be taxed more efficiently if they were left to their own categorization. It has the effect in an RSP of converting these other types of tax-advantageous income into straight withdrawals.

In a TFSA, for example, there’s no tax whatsoever. So, when deciding between do we put a specific type of investment in a TFSA, an RSP, or a non-registered account altogether, it’s important to consider, well, what are the tax impacts going to be of these different type of investments, both on a year-to-year basis, as well as a tax-on-death basis?

Leanne Kaufman:

Okay, so anybody that’s listening, that’s like, I got to get on this, they want to take some action. What do you think could be an initial first step to take straight away to review and maybe make some tweaks to theirestate plan as it relates to their RRSP?

Ali Spinner:

I think, number one, consider if you should actually be taking out more than the minimum each year. Consider if, yes, you should prepay some tax, but will your heirs be better off by having you prepay some tax at a much lesser amount versus put off the date that the tax will be due but at a much higher amount? That is absolutely something that people can take action with right away. As well, you should speak to your financial advisor to determine, do you have a designated beneficiary? Have you made that designation in your plan documents? If not, can you do so now?

Leanne Kaufman:

And are there any triggers or milestones, life events that you think should really jolt someone into having this conversation with their planner or thinking about these issues in particular?

Ali Spinner:

I like to say that whenever there’s change in our lives, it’s a great time to take a step back and look at our estate planning assets and determine if they’re organized in a way that’s fulfilling our goals and objectives. I say when there’s changes in life circumstances:

• If all of a sudden our income has gone up a lot, has our income decreased a lot?
• Do our cash requirement needs, have they increased? Have they decreased?
• Have we received an inheritance?
• Do we have an unexpected large renovation that we have to take on for the house? And do we have to draw excess money out of an account somewhere?

So, whenever there’s change, we certainly have to take a step back and look and make sure that everything is working according to plan.

Leanne Kaufman:

Of course, the one thing that we haven’t talked about, but I think is always good advice when we’re talking about estate planning generally is don’t do anything in isolation, right? Don’t do something to your RRSP without making sure someone’s also looking at your Will and so on, right? I mean, we want to make sure everything’s always copacetic together.

Ali Spinner:

You’re absolutely right. All of this planning really works together. If we’re aiming for the best result possible, it’s important to take that step back and look at it from all different angles to make sure that we haven’t either created something that doesn’t take into account the results of something else.

Leanne Kaufman:

Well, this has been great, Ali, and I’m sure our listeners have learned a lot and probably now are interested to go and get some advice on their own. But if you hope that the people listening just take one thing away, which is hard to do in a complex topic like this, what would that one thing be?

Ali Spinner:

The one thing would be take a look and see if you or a parent should perhaps increase the amount that you’re withdrawing from your RRSP or RRIF in any given year to take advantage of those low tax rates.

Leanne Kaufman:

That’s a great tip and one that I’m sure more people need to know about.

Well, thank you so much, Ali, for joining me today to help us better understand all these important nuances tied to RRSPs and RIFs in estate planning and why this matters beyond wealth.

Ali Spinner:

Thanks so much for having me.

Leanne Kaufman:

You can find out more about Ali Spinner on LinkedIn or at crowe.com.

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.