RRSPs and estate administration

Most Canadians use RRSPs as a savings and investment vehicle for retirement, due in part to tax-deductible contributions, employer contribution opportunities, and tax-sheltered growth. As a result, the plans tend to feature prominently in most Canadians’ estate plans.

In conventional planning, RRSPs are passed on to surviving spouses or common-law partners in first-to-pass scenarios. RRSP rollovers or transfers allow such beneficiaries to receive the benefits of the deceased’s RRSP and defer tax until a later date.

However, there are cases when a person is widowed, unmarried or unpartnered, does not wish to pass on an RRSP to a partner or has no other eligible beneficiary (such as a qualifying disabled minor). In these instances, determining the ideal beneficiaries requires significant planning and re-evaluation, as beneficiary designations can carry serious consequences for estates. In these cases, whether someone opts to name RRSP beneficiaries or directs their RRSP to their estate to allow the net proceeds after tax to be subject to trust terms or otherwise distributed as they determine in their will, the RRSP transfer at death will trigger a tax event.

While naming beneficiaries can have positive outcomes in the right circumstances, such as potential savings in estate administration taxes/fees and expediency of transfer to intended beneficiaries, there are significant risks and drawbacks when not properly considered.

Unlike with many RRSP withdrawals during life, financial institutions generally do not withhold any tax from RRSP proceeds transferred to a beneficiary on death. The result could be tax liability to the estate, as the funds move elsewhere and leave the estate with a cash shortfall. When this occurs, both the executor and RRSP beneficiary can expect to hear from the Canada Revenue Agency (CRA).

Consider the following hypothetical scenario:

• Mr. X is unmarried with no partner or children, and his assets consist of an RRSP valued at $300,000 and a bank account with $80,000. He rents an apartment in downtown Edmonton and has a full-time job earning roughly $60,000/year. His personal effects have nominal financial value.
• In his will, Mr. X named his estate as the beneficiary of his RRSP.
• His will also states that his sister, Ms. Y, and her children will benefit from the net proceeds of his estate.
• Six months after drafting his will, Mr. X visits his bank and designates his RRSP to Ms. Y. He felt this would shorten administration, allow his sister access to the money sooner, and be simpler. As this new designation supersedes the designation in the will,[1] he did not feel he needed to update his estate plan with his lawyer.
• Mr. X passes away shortly thereafter, and the RRSP passes to Ms. Y outside of the estate.
• Mr. X’s estate has a tax liability at death of roughly $125,000 (plus interest and penalties if paid late).
• Since the RRSP did not enter the estate, the estate has only the $80,000 in the bank account to cover debts, taxes, and administration costs. As a result, the estate is insolvent and does not have sufficient cash to pay the tax liability.  
• In the meantime, Mr. X’s executor used some of the $80,000 in the bank account to pay for funeral expenses, legal fees, some administration expenses, and tax return preparation.
• The executor also paid Mr. X’s credit card bills and final month’s rent, totalling roughly $10,000.
• There is only approximately $55,000 remaining in the estate’s bank account.

The result? Mr. X’s estate and Ms. Y are both liable for tax arising from the RRSP, and Mr. X’s executor is personally liable for up to $10,000.

Why is Ms. Y liable? Subsection 160.2(1) of the Income Tax Act renders a taxpayer who received a benefit from an RRSP, as a consequence of the annuitant’s death, liable with the annuitant for the income tax on the benefit arising at death. As Ms. Y received an approximate benefit of $300,000, she would be potentially liable for the remaining tax owing, as the benefit received exceeds the amount of tax owing.

Why is Mr. X’s executor personally liable? Subsection 159(3) of the act states that a legal representative (including an executor) becomes personally liable up to the value of the deceased taxpayer’s property that is distributed if there is a tax liability. This personal liability can extend to both unpaid taxes and any accrued interest.

However, an executor may be granted an “allowance” for “reasonable funeral, testamentary and administration costs.”[2] This is consistent with court rulings in Alberta, which have held that “even with an insolvent estate, funeral, testamentary and administration expenses are paid in priority to other claims and bequests.”[3]

While funeral expenses, legal fees, administration expenses, and tax return filing are generally considered in priority to CRA as an allowance and not considered subject to the application of ss. 159(3), rent and credit card payments are generally not. As a result, even if it was otherwise prudent for the executor to avoid added interest payments on the credit card and reasonable to close off the rental, the CRA may assess the executor for up to $10,000, as he distributed that amount in priority to the CRA’s tax claim.

Assuming that the estate used the remaining $55,000 to partially repay the CRA, such amount will first be allocated to the income tax owing on Mr. X’s taxable income and then allocated to the amount owing on the RRSP at death.

While any payment from Ms. Y or Mr. X’s executor will reduce the amount the other owes under ss. 160.1(2), there is no bright-line test as to who pays first. They both face liability. This could lead to further delay and dispute, which may serve to increase the cost of the final tax bill and administration costs.

How could this situation have been avoided? Ironically, in this instance, by doing nothing.

Mr. X already had an effective plan in place, and if he sought to make changes, he should have discussed them in advance with his professional advisors.

As there was no apparent tax benefit to naming Ms. Y as beneficiary on the RRSP, it could have been more prudent to leave the estate as beneficiary. This way, the estate would have had ample cash on hand to pay all debts and taxes, and then pass on the remainder to Ms. Y, as well as her children.

Unlike most Canadian provinces, Alberta currently has a maximum probate fee of $525, whether the estate is valued at $250,001 or $250 million. That said, even in provinces that charge up to 1.5% in tax on the value of the estate, like Ontario, care should be taken in addressing the desire to reduce probate tax, given the potential to create estate issues and tax liability.

Even if this scenario took place in Ontario, based on a $380,000 estate, the amount of savings in bypassing the estate by naming RRSP beneficiaries would be roughly $4,500. An amount in excess of this number is now likely to be borne by others (as well as the estate) in penalties, interest and additional professional fees.

As the bank account had significant funds, there was already a need to obtain a grant of probate, so there were no savings there. While a financial institution may hypothetically waive the requirement for probate on smaller accounts, it is under no obligation to do so, and may require a grant for any amount.

While Ms. Y received funds quicker than she would have if she had to wait for a distribution from the estate, she now must deal with the CRA, and those delays may result in her keeping less of the RRSP proceeds than she would have if they entered the estate first.  

Even in cases where the outcome may not be as dire as this case study, it is strongly recommended that beneficiary designations, especially on registered plans such as RRSPs, be reviewed regularly with qualified professionals. Any changes to these designations should also be assessed in advance.

[1] Wills and Succession Act, SA 2010, c W-12.2, ss. 71(7)

[2] For examples, see CRA Roundtable, STEP conference, 2011-0429101C6 and CRA technical interpretation 2010-0390311E5

[3] Boje Estate, 2009 ABQB 749 at paragraph 44