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TFSAs, RRSPs, RRIFs, and the importance of beneficiary designations

So, you’ve recently updated your will—great, but what about your beneficiary designations?

If we lost you at ‘beneficiary designations’ and you’ve got registered investments (e.g., TFSAs, RRSPs, RRIFs), then you’re definitely going to want to grab a tea or coffee and read on.

But first, what exactly are beneficiary designations and why do you need them?

Put simply, beneficiary designations allow you to transfer investment assets directly to the people you want (upon your passing), regardless of the terms of your will.

That last detail is the ultimate ‘raison d’être’ for needing to have beneficiary designations in place.

Case and point, there is a Canadian woman whose spouse recently passed away. To protect her identity, we’ll call her Jane. Thinking she had all the right documents in place (including an updated will from her husband, Marc, which left her everything), Jane called Marc’s financial institution to get the proceeds of his Registered Retirement Savings Plan transferred to her own RRSP.

But there was a hitch—and quite a significant one.

Upon speaking with her husband’s financial institution, Jane discovered that Marc’s ex-wife was still designated as the sole beneficiary on his RRSP accounts (you probably see where this is going). That meant regardless of the updated will or the divorce agreement (where Marc and his ex-wife both signed away rights to each other’s assets), Jane would receive absolutely nothing from these accounts.

And it all came down to one minor detail.

Because he had not updated his beneficiary designations before his death, Marc had inadvertently gifted the assets of his RRSP accounts to his ex-wife.

If that wasn’t upsetting enough, Jane also found out there was a literal price she had to pay for her husband’s oversight.

Since the proceeds of Marc’s RRSP were not transferred to his current spouse, his estate would then be responsible for paying the tax on the value of those assets in its entirety. This meant that Jane had to pay the nearly 50% tax on the value of the RRSPs. A very unfortunate and costly example of how outdated (or a lack of) beneficiary designations can lead to unnecessary distress over and above the grief already being experienced by loved ones.

To avoid this kind of scenario, be sure to get all of your beneficiary designation ducks in a row.

When it comes to your own registered accounts, you have the option of designating the following:

  • A beneficiary (inherits the assets in your account without inheriting the actual account)
  • A successor (takes ownership of your account in its entirety, including all assets)

Your ability to name a beneficiary or successor depends on which registered accounts you have: 

 Account Type  Beneficiary Options
 Registered Retirement Savings Plan One or more beneficiaries
  Registered Retirement Income Fund One successor annuitant or one or more beneficiaries
 Tax-Free Savings Account One successor holder or one or more beneficiaries

If you’re wondering as to why RRIFs have a successor annuitant and TFSAs a successor holder, it’s simply a naming convention to differentiate between the two.

Next, let’s further explore the differences between beneficiaries and successors by account type. 

RRSPs:

  • Anyone can be named as a beneficiary (or beneficiaries)
  • If the designated beneficiary is your spouse or common-law partner and the money is transferred to their own registered account, no tax has to be paid on the amount transferred until they withdraw the funds themselves (i.e., the funds are transferred tax-free to the new owner and not considered a sell of the funds)
  • The transfer will also be tax-free until the funds are actually withdrawn if the named beneficiary is a financially-dependent child or grandchild, so long as they are under 18 years of age or are mentally or physically infirm (in which case that child can be of any age and the funds are deposited in a Registered Disability Savings Plan)
  • If your designated beneficiaries are not a spouse/common-law partner and/or dependent child/grandchild, the full value of the RRSP will be taxable in the year of your passing (this will also be the case should your spouse/common-law partner and/or dependent child-grandchild choose not to transfer the funds into their own RRSP, RRIF, or RDSP)
  • Be sure to note that your RRSP beneficiary designation does not automatically carry over when you convert that RRSP to a RRIF (you will have to create a new designation—see below for your options)

RRIFs:

As stated in the chart above, you can list either a beneficiary or a successor annuitant on your RRIF.

Naming a beneficiary:

  • Can literally be anyone (friend, family member, neighbour, or even your estate)
  • To benefit from the deferral of taxes, the same rules apply as with RRSPs (i.e., designated beneficiary must be a spouse/common-law partner or dependent child)
  • If you end up designating your spouse or common-law partner as a beneficiary of your RRIF, and they elect to transfer the entire amount directly to their own registered plan, those assets would be transferred to them upon your death and your RRIF account closed (in this case, your estate will not have to include the value of the RRIF in your posthumous tax return, nor would it have to pay income tax on that amount)—same goes if you name a financially-dependent minor (or mentally/physically infirm) child or grandchild as your beneficiary
  • If you opt for a beneficiary outside of a spouse/common-law partner (or financially-dependent minor or mentally/physically infirm child/grandchild), the assets in your RRIF upon the date of your passing would be included in your posthumous tax return

Naming a successor annuitant:

  • This person is limited to your spouse or common-law partner
  • As a successor annuitant, they are able to take over your RRIF upon your passing, without having to transfer out the funds (effectively assuming ownership of the account with no tax consequences to the estate)
  • Your spouse/common-law partner can then choose to continue receiving those RRIF payments or transfer the assets to their own RRIF
  • If they are under 71 years of age and want to delay payments, your spouse/common-law partner can also decide to move all of your RRIF funds to their RRSP without impacting contribution room (as an education member, this is something to keep in mind since your own RRSP contribution room tends to be quite limited)

TFSAs:

When it comes to your TFSA, you can designate either a beneficiary or a successor holder.

Naming a beneficiary:

  • Similar to RRIFs, a beneficiary can be anyone you choose
  • While beneficiaries will receive the assets in your TFSA completely tax-free up to the date of your death, they will be taxed on any growth in the account until the funds are disbursed
  • Beneficiaries can also use the assets in your Tax-Free Savings Account to contribute to their own TFSA—as long as they have available contribution room
  • On the other hand, if you name your spouse or common-law partner as your beneficiary, they can choose to make an exempt contribution—where they use the assets in your TFSA to contribute an amount to their own account that is not limited by their available TFSA contribution room
  • Note there is a short window after a TFSA holder’s death to make an exempt contribution, so if keeping your TFSA intact is important to your surviving spouse or common-law partner, it is probably much easier to simply name them as a successor holder (see below)

TFSA Master Class – Lesson 2: How to avoid the over-contribution confusion

Naming a successor holder:

  • Only your spouse or common-law partner can be designated as a successor holder
  • Again, similar to a RRIF, they would take over full ownership of your TFSA—where they could choose to roll that account into their own TFSA without impacting contribution room
  • Unlike a TFSA beneficiary, however, being a TFSA successor holder means your spouse or common-law partner would not have to pay tax on any asset growth from the date of your death until the time they withdraw funds from the account (i.e., 100% tax-free)

When it comes to figuring out whether you should go the beneficiary or successor route, a little perspective can go a long way.

That’s where Educators Financial Group comes in.

We’ll guide you through the entire beneficiary designation process step-by-step, answering any questions along the way. Plus, having worked with education members for almost five decades, we’re well aware of the various intricacies that come from working in your field. Important details that will help you to not only decide what’s best when it comes to your registered accounts, but also provide you with much-needed peace of mind when it comes to the legacy you leave behind.

Avoid ending up like Jane: let’s get your beneficiary designations sorted ASAP

Plus be sure to check out:

Estate planning essentials for education members at every age
Here’s why your estate plan needs to include digital assets

Source:
https://www.edwardjones.ca/ca-en/market-news-insights/beneficiary-designations-compelling-case

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