Tax Cautions for Assets Passing Outside of the Estate
As the saying goes, there are two certainties in life: death and taxes. When it comes to estate planning, the primary consideration for many clients is the preservation of as much of their wealth as possible. One important way to do this is through tax planning.
Trends in the cases that are hitting the courtrooms demonstrate a common misconception about RSPs and RIFs. These often stem from a desire to avoid probate fees, but can have unintended, often unfair, consequences.
MISCONCEPTION: Naming a beneficiary on an RSP or RIF avoids probate fees and therefore there will be more value in the residual estate to go to the beneficiaries of the Will.
Be careful here. While it’s true that probate fees are avoided, don’t forget about income taxes.
TRUTH: The estate may owe income tax on those plans (even with the designated beneficiary in place), and this REDUCES the residual estate of the deceased person.
It is true that structuring your assets so that as much as possible passes outside of your estate is beneficial, because it reduces the size of your estate on which probate fees are paid. But probate fees shouldn’t be the driver for all decisions. Sometimes, that cost savings is negated by the other problems that result.
We previously updated you on best practices to avoid disputes over RIFFs and RRSPs. Recall, tax liability for assets passing outside of the estate is joint and several between the beneficiary and the estate, but the CRA will generally assess the estate first.
As a result, you may avoid probate fees by designating a recipient but the asset will still trigger income tax for the deceased persons, payable by his/her estate. That tax has to be paid first, before any gifs in the Will can be fulfilled.
There are a few exceptions. For example, where the spouse is designated as successor annuitant of the RRSP or RRIF, the funds can be rolled into to the spouse’s registered account, and tax is deferred until the spouse withdraws the funds.
But, if the beneficiary is not a spouse, the tax is not deferred, and is immediately payable by the estate of the deceased.
Thus, if the deceased has named one individual as the beneficiary/successor annuitant of the RSP/RIF, that person receives the cash value, without paying the tax. The tax must be paid by the estate. If the beneficiaries of the estate are not the same as those receiving the RSP/RIF funds, then this creates a mis-match. Effectively, the Will beneficiaries will, by default, bear the burden of the tax on the RSP/RIF.
In extreme cases, the estate may be depleted by paying the tax and there may be no residual left for the beneficiaries of the Will.
Having assets pass outside of the estate can be an effective tax-planning tool but it is not a one-size fits all approach. The repercussion of “easy” ways to avoid probate tax can be the failure to plan effectively for the burden of income tax. Talking with a professional estate advisor who can help you see the big picture is the smartest way to preserve your wealth and legacy.