Question. I’m planning to open an RRSP, but I don’t really know who to indicate as the beneficiary of the plan. Is this important?
Answer. Yes, very important! And not just for RRSPs, but for registered plans in general, as well as life insurance policies, too.
In Canada, life insurance policies and registered plans such as RRSPs allow for a named beneficiary. Getting this right is extremely important for a number of reasons, and conversely, getting it wrong can be very costly.
Key Benefits of a Named Beneficiary
In short, the key consideration regarding a beneficiary designation is, “What happens when the planholder dies?” When there is a named beneficiary on a life insurance policy or registered plan, the proceeds will flow directly to that named beneficiary and will not be included in the deceased’s estate. This presents 3 key advantages:
The processes of probating and administering a deceased individual’s estate can often be quite a lengthy process. With a named beneficiary, the assets pass outside the estate much more efficiently. This helps ensure your intended heirs, family, and loved ones receive those assets without unnecessary delay.
- Creditor Protection and Privacy
In general, estate information is available to the public. This means that assets passing through your estate are generally visible to others. Further, assets in your estate are generally exposed to potential creditors. Again, by naming a beneficiary on registered plans and life insurance policies, those assets are kept private and also protected against claims from potential creditors.
- Minimize Probate Fees
Probate is a legal process which includes the validation of a deceased individual’s will, and the formal appointment of an executor to the deceased’s estate. Although the probate rules and fees vary from one province to the next, the cost associated with the probate process is generally a function of the monetary value of the deceased’s estate. To that extent, using a named beneficiary to keep assets outside your estate helps save money and preserves the value of your estate.
To illustrate the impact of probate fees on an estate, let’s consider the province of BC, which has the following probate fee schedule:
- $200 dollar filing fee (unless the value of the estate is below $25,000);
- 0.6% on the value of an estate between $25,000 and $50,000; and
- 1.4% on the value of an estate over $50,000.
Now, assume a simple scenario where a resident of BC dies with a $1 million life insurance policy. In this example, even if the individual had no other assets than the life insurance policy, naming a beneficiary on the policy would result in a savings of $13,650 of probate fees. If you’re wondering about the potential impact of probate fees on your estate, you can try this online probate fee calculator for your specific province of residence.
Let’s take a closer look at the implications of named beneficiaries, or lack thereof, for both registered plans and life insurance policies.
RRSPs and Registered Plans
What many people do not realize, is that upon death, the proceeds of registered plans (other than a TFSA) are subject to regular income inclusion, and therefore full taxation. Naming a beneficiary doesn’t allow you to escape taxation, but it does allow you to escape probate, and ensure those assets pass directly to your designated beneficiary rather than through your estate.
Note that there are a few exceptions to the registered plan tax liability upon death. In particular, when the beneficiary of a registered plan such as an RRSP or RRIF is a surviving spouse or disabled child, the transfer can happen on a tax-deferred basis. However, in the absence of a surviving spouse or disabled child, the fair market value of an RRSP or RRIF is included in the deceased’s estate as taxable income.
Although it is the responsibility of the deceased’s executor (or legal representative) to pay the taxes owing upon death, the beneficiary of the RRSP or RRIF is also jointly liable. That is, if the executor fails to pay the taxes owing, the CRA can take action against the beneficiary named on the RRSP or RRIF. As an example, consider a deceased’s estate with a 40% marginal tax rate, and a $500,000 RRIF. In this case, and in the absence of a surviving spouse or disabled child, the taxes owing upon death would be $200,000.
To highlight just how important this is, and how costly a simple mistake can be, consider this very unfortunate story, of a woman in Calgary who was forced to pay over $270,000 to the CRA for a beneficiary oversight. Even though her husband had properly named her as beneficiary on his RRSP, he forgot to do so when converting his RRSP to a RRIF.
As a reminder, here are some of the most common registered plans with beneficiary designations:
- RRSP – Registered Retirement Savings Plan
- RRIF – Registered Retirement Income Fund
- TFSA – Tax Free Savings Account
- LIRA – Locked-In Retirement Account
- LRIF – Locked Retirement Income Fund
- LRSP – Locked Retirement Savings Plan
Life Insurance Policies
In Canada, life insurance policy proceeds, known as the death benefit, are paid out 100% tax-free. This is always the case, whether or not there is a named beneficiary on the plan. Further, this includes all types of life insurance:
- Term policies, such as Term 10 or Term 20;
- Permanent policies, such as Universal Life, Whole Life, and Term-to-100;
- Group policies through employer benefits plans.
However, while benefits are always paid out tax-free, in the absence of a named beneficiary, the life insurance proceeds are typically paid to the deceased’s estate. As described above, when this happens, the proceeds may be subject to probate fees, and may be exposed to potential creditor claims.
Review your registered plans and insurance policies, and make sure you have made the appropriate beneficiary designations wherever possible. Of course, while marriage, divorce, separation, and having children are some of the most common triggers to review your beneficiary designations, a regular review is always a good idea, to ensure your beneficiary designations are properly aligned with your final wishes.
If you’re interested in learning more about beneficiary designations, or would like to have a discussion with a Portfolio Manager or Certified Financial Planner, just contact us.