Last week, I wrote about the most efficient way to withdraw from your accounts during retirement. Within the article, I mentioned that while the general rule of thumb is to keep your RRSP as long as possible, there are some situations where drawing down on your RRSP first makes the most sense.
This is particularly evident if the RRSP holder passes away early which could result in high taxation on the RRSP balance either immediately (no spouse or financial dependants) or in the future. It’s also interesting to note that a number of financial models conclude that withdrawing from your TFSA should be your last account to touch. Of course, every situation is different, so I will be looking into different scenarios in a future post.
Going through that exercise for my personal situation, it made me self-reflect, and start to think about estate planning. What exactly happens to your RRSP and TFSA after you die? What is the most tax efficient way to pass on your retirement accounts to the next generation or to charity? Let’s take a look!
What Happens to an RRSP when you Die?
To start off with the good news, RRSPs can generally “rollover” tax-free to qualified beneficiaries such as:
- a spouse/spousal trust/common-law partner;
- financially dependent children/grandchildren under 18;
- or disabled children/grandchildren of any age.
From a paper trail perspective, the beneficiary will need to report the RRSP assets on their tax return, but the beneficiary will receive a tax deduction to offset the taxes owed. Another benefit of having a qualified beneficiary is that it avoids estate probate tax, which can add up!
Will as a backup! If you have an eligible beneficiary in your life, make sure that your discount brokerage has it on file! As an alternative, a qualified beneficiary named in the RRSP holder’s will and last testament is also eligible for the rollover.
Charity is another option! If you don’t have a tax-free beneficiary as stated above, your estate will pay taxes on the RRSP as if it is liquidated the year that you die (plus probate). One alternative is to choose a charity as the beneficiary which would result in a tax credit that would reduce or eliminate taxes due from the RRSP.
What about an RRIF?
What if the RRSP has been converted to an RRIF? Similar rules to an RRSP, but with one slight difference. A spouse can be named either a “beneficiary” or a “successor annuitant.” Instead of having all the assets liquidated and transferred over to the spouse’s account (beneficiary), a successor annuitant can simply take over the existing RRIF account.
There are a couple of advantages. The first is timing – what if the liquidation happens during a market down cycle? Another advantage is that there is much less paperwork involved with a “successor annuitant” designation. Who wants more paperwork?
Here are some articles with more detail if you are interested:
What Happens to a TFSA when you Die?
Now that we have the RRSP out of the way, what happens to a TFSA? The beauty of the TFSA is that it is funded with after-tax dollars, which means that there are no withdrawal taxes which carries on even after you pass away.
But even without withdrawal taxes, the estate can face probate taxes if the accounts are not designated properly.
For TFSA’s, you have two options for tax-efficient distribution (ie. no estate probate taxes):
- Successor Holder (Spouse/common-law)
- Beneficiary (spouse/common law/anyone else)
Electing your spouse/common-law partner as a Successor Holder on the account is likely the most efficient way to go. Similar to the “Successor Annuitant” for RRIFs as explained earlier, this will allow the spouse/common-law partner to simply take over the account with very little in terms of paperwork.
A beneficiary will also receive the funds tax-free, but there is a tax payable if the account rises in value from the date of death to the date that the funds are transferred. Still a pretty good deal, it’s just that the beneficiary will need to act fast!
The best solution? As stated on Retire Happy Blog, assign a Successor Holder if you can, but also assign a backup beneficiary. If both you and your spouse pass away at the same time, this would help avoid running the TFSA funds through the estate thus avoiding probate taxes.
How do I set up a Beneficiary/Successor Holder in my RRSP/TFSA?
When you originally signed up for the account, the discount brokerage would have asked for beneficiary information. Any changes can be made by contacting your discount brokerage and they will give you the appropriate forms to fill out. I would suggest to get on the ball and get this completed sooner rather than later.
When I recently checked my accounts (like right before writing this post), my RRSPs were assigned properly, but my TFSA only had a beneficiary and not a Successor Holder. I’m planning on getting those forms completed before the end of this week.
If I were to summarize this article, I would say to make sure you have the correct beneficiaries set in all of your registered accounts. If you are not sure, the best bet is to contact your discount brokerage and complete the appropriate forms if you need to make changes.
The biggest thing I learned while doing research for this article was to set a Successor Holder for your TFSA along with a backup beneficiary. This has two advantages. First, it will allow your spouse/common-law partner to take over your account without the added paperwork and potential tax. Second, if both spouses pass away at the same time, assigning a backup beneficiary will ultimately help avoid probate tax, and in our case, make our kids/designated charity a little richer.