Minimizing tax at death on RRSP – Part 1

By Michael Bronstine

In this first of two articles, we’ll look at three options for transferring an RRSP at death, and how you can help.

Almost 6 million Canadian tax filers contributed to an RRSP in 2016, down a bit from 2015.  But they may not know about a major tax hit that can occur at death (since Canadian law deems them to have cashed in their entire RRSP or Registered Retirement Income Fund (RRIF) when they die). In fact, when someone passes away, all or a large part of their registered plans could be taxed at the maximum marginal rate.

How can you help reduce the taxable impact?

Good planning is key

In general, through good planning, you can shift all or a portion of the tax burden on a deceased person’s registered plans to someone who can defer tax or who will pay tax at a lower rate. If there’s a qualified beneficiary and certain conditions are met, it’s possible to keep the entire amount from being included in the deceased’s income. And qualified beneficiaries acquiring an RRSP or RRIF under these circumstances can also apply tax-deferral strategies on registered money received due to a death.

In this first of two articles, we’ll look at three options for transferring an RRSP at death. The second article will present additional solutions and address RRIF transfers at death.

Option 1: Direct RRSP transfer to the surviving spouse or common-law partner via a beneficiary designation

You can prevent an RRSP from being included in the deceased’s income when all or part of the funds qualify as a ‘refund of premiums.’ The Canada Revenue Agency (CRA) requires three conditions for this qualification:

• The spouse or common-law partner must be the solebeneficiary designated within the contract registered as an RRSP, or in the will.
• The spouse or common-law partner must instruct the RRSP issuer to transfer the RRSP property directly into another RRSP, RRIF or annuity in their name.
• The transfer must occur within 60 days of the end of the year that the spouse receives or is deemed to have received the refund of premiums. Prior to December 31 of the year following death, all assets in the RRSP are transferred directly into an RRSP, a pooled registered pension plan, a specified pension plan or a RRIF on which the spouse is the annuitant or used to purchase a qualifying annuity for the spouse.

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When these conditions are met, the RRSP is transferred tax-free and isn’t treated as income for the deceased.

Option 2: RRSP benefit to be received by the estate

In all other cases, the RRSP benefit is deemed to be received by the estate trustee. The amount of tax will then depend on the joint decisions made by the beneficiary or heir and the estate trustee.

What happens if the spouse or common-law partner is an heir of the estate (regardless of the type of bequest they’re entitled to) or if a qualified beneficiary doesn’t meet one of the required conditions for making a direct transfer? In this case, the estate trustee and the spouse or common-law partner can designate the payment as a refund of premiums and jointly sign CRA form T2019. The spouse or common-law partner is then deemed to have received the amount directly, versus through the estate trustee.

This decision will reduce tax payable by the deceased. The recipient spouse or common-law partner must, however, include the refund of premiums as income on their own tax return in the year received. To avoid being taxed on these amounts, the spouse or common-law partner must contribute the money they receive to an RRSP, RRIF or annuity, and then deduct that amount from their income.

Note that the transfer must occur in the year the refund of premiums is received or within 60 days of the end of the year.

Although more complicated than option 1, the result is the same: the registered money moves tax-free to the surviving spouse or common-law partner’s RRSP, RRIF or annuity, and isn’t treated as income for the deceased.

Option 3: Transfer to a financially dependent minor child or grandchild

A person with a financially dependent child or grandchild (‘child’) under age 18 immediately before their death can transfer an RRSP to that child, even if there’s a surviving spouse or common-law partner. As for the deceased’s taxes, similar conditions as those listed in option 1 apply:

• The child must be the sole beneficiary of the RRSP, as designated in the RRSP or in the will.
• The child (through their legal representative) must instruct the RRSP issuer to transfer the RRSP property directly into a term certain to age 18 annuities in the child’s name. The estate trustee and the child’s legal representative must complete the required form (CRA form T2019) with the required adjustments, if applicable. The transfer of a refund of premiums from the deceased to the child eliminates the tax on that money for the deceased.
• The transfer must occur within 60 days of the end of the year that the child receives or is deemed to receive the refund of premiums. The child will receive tax slips in their name indicating ‘refund of premiums’. The child will need to include the refund of premiums in income, but the transfer of that money to the annuity generates an offsetting deduction, resulting in no immediate tax to the child. Only the annuity payments a child receives during the tax year are treated as income, providing a measure of tax deferral.