Estate Planning for RRSPs 

Tax Strategy

Estate Planning for RRSPs

FROM: SEP-OCT 2006 ISSUE | BY FRANCINE ST-ONGE

Contributing to an RRSP (registered retirement savings plan) not only involves planning for retirement, but also requires a plan to pass on this major asset in the event of death. The fiscal impact of an RRSP that has not yet matured may be considerable, since the general rule is that the fair market value of the RRSP is added to the deceased person's income for the year of death. But there are ways to reduce the financial burden.

RRSPs are generally rolled over to the RRSP of the deceased person's spouse. However, other scenarios are possible, as long as they conform to the rules set out in the Income Tax Act (the Act).

General Rule

According to the general rule, the fair market value of an RRSP at the time of death is included in the deceased person's income for that year and taxed at their marginal rate. Since this amount is added to the deceased person's income, including income and capital gains from deemed disposition at death, it is likely that most or all of the RRSP will be taxed at the highest rate.

Transferring all or part of the RRSP to someone whose tax rate is lower or who will be able to defer taxation by rolling it over to a deferred income plan or purchasing an annuity reduces the rate of taxation.

Spouse or Common-law Partner

When a spouse or common-law partner is designated the beneficiary of the deceased person's RRSP, the amount paid to him constitutes a "refund of premiums." As such, it can be deducted from the amount included in the deceased person's income and added to the income of the spouse or common-law partner. The recipient is then authorized to transfer the amount on which he is taxed to an RRSP of which he is the beneficiary, and claim a corresponding deduction when calculating his income. Accordingly, the tax on the amount transferred is deferred until the money is withdrawn from the RRSP.

Under the Act, there is no requirement that the entire refund of premiums be deducted from the deceased person's income. The amount not deducted can be transferred to the beneficiary without being taxed again. This offers an opportunity to reduce the fiscal impact when one does not wish to roll over the entire RRSP to the spousal or common-law partner RRSP. Publication RC4177 of the Canada Revenue Agency (CRA), entitled Death of an RRSP Annuitant, specifies how to proceed in order to claim all or part of the deduction for the refund of premiums.

Consider the case of Jeannette, who died on February 15, 2005. At the time of her death, the fair market value of her RRSP was $300,000, and her income for the year was $15,000. She had no income or capital gains from the deemed disposition of her property at death. Her husband Matthew was the designated beneficiary of the RRSP and had an income of $90,000 for 2005. He also had an RRSP with a value of $575,000. Matthew wanted to cash $50,000 from his wife's RRSP immediately and transfer to the rest to his own RRSP.

To reduce the tax burden on the $50,000 not transferred to Matthew's RRSP, it is possible to take maximum advantage of progressive tax rates. Since Jeannette had little income in 2005 and her marginal tax rate was much lower than Matthew's, it is preferable to include the $50,000 in her income rather than Matthew's. This can be done by claiming a $250,000 deduction against the $300,000 that Jeannette must include in her income for the RRSP. Matthew, in turn, would include $250,000 in his income and claim a $250,000 deduction for the transfer to his RRSP. As a result, his income would not be affected.

When the estate of the deceased is the beneficiary of the RRSP, it is possible to use the rollover to the spouse or common-law partner if, under the terms of the will, he or she is entitled to a total bequest, excluding bequests of specific items, equal to or greater than the RRSP. The election must be made by filing Form T2019.

When the bequest to the spouse is for an amount less than the value of the RRSP, it is only possible to roll over an amount corresponding to the bequest. In some provinces, the designations made when subscribing to certain types of RRSPs are not valid and the RRSP is included in the estate despite prior designation. Therefore, it is best to make sure the designation is valid. If it is not, Form T2019 can be filed to obtain the rollover to the spouse within the above-mentioned limits.

Dependent Child or Grandchild

When a child or grandchild financially dependent on the deceased person at the time of death is designated the beneficiary of the RRSP, the amount paid is also considered a refund of premiums. It may therefore be deducted from the amount to be taxed as part of the deceased person's income.

A child or grandchild is considered dependent if his income in the year preceding the death does not exceed the amount used to calculate the basic personal tax credit for that preceding taxation year ($8,839 for 2006, $8,648 for 2005). In the case of a child or grandchild who is financially dependent because of a physical or mental impairment, the income threshold is increased by $6,180, indexed since 2003 ($6,741 in 2006, $6,596 in 2005, resulting in a total amount of $15,580 in 2006 and $15,244 in 2005).

Any child or grandchild of the deceased with an income greater than the above-
mentioned limits is not eligible for a refund of premiums. When a grandparent gives the occasional gift to a grandchild, this does not constitute financial dependence.

The refund of premiums received by a financially dependent child or grandchild may be included in his income rather than in the income of the deceased. Since the child has little income, this is generally advantageous. Also, if the deceased person's income is small, the taxation of the RRSP can be divided between the child and the deceased so as to minimize the tax burden.

It is possible to defer taxation of the RRSP in two cases. First, the child or grandchild who is financially dependent because of a physical or mental impairment can transfer the taxable amount of the refund of premiums to his own RRSP, thereby deferring its taxation until withdrawal. The second possibility applies to minor children or grandchildren: taxation of the RRSP can be spread over a number of years by purchasing a qualifying annuity with a term not exceeding 18 years less the age of the dependent child or grandchild at the time the annuity is acquired.

In conclusion, planning for the taxation of an RRSP upon death should take several variables into account, and there is no one formula that applies to all cases. Rolling over the entire RRSP to the spousal RRSP may not be the best solution considering the spouse's age, health status, and income. Don't forget that the purpose of estate planning is not only to reduce taxes but also to pass on one's property in an orderly fashion to the desired recipients.

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Francine St-Onge, BBA, BCL, LLB, FCGA, practises tax and corporate law in Sutton, Quebec. She is co-author of the CGA-Canada course Taxation 2.

"Tax Strategy" is co-ordinated by J. ThomasMcCallum, CBV, FCGA, a business valuation and income tax consultant based in Whitby, Ontario, and author of several CGA-Canada professional development courses. E-mail jtmc@jthomasmccallum.com.

The information appearing in "Tax Strategy" is provided for the interest of the readers. Neither CGA Magazinenor the column authors and co-ordinator assumes any responsibility or liability to any persons relying on the information in the article to perform tax planning and/or compliance of any kind.