Estate planning and tax planning usually intersect. This can have significant property and tax implications for the naming of non-spouse beneficiaries on registered plans.
This is relatively easy if a client intends to transfer all wealth to his or her surviving spouse, including full tax-deferred rollover of registered plans.
Read: How to make a Power of Attorney ironclad
But commonly, children are named as beneficiaries of both the estate and any registered plans. This usually helps avoids probate tax on the registered plan as well, keeping it out of the reach of the deceased’s creditors, speeding the release of the proceeds and perhaps reducing estate administration costs. (For the sake of discussion, let’s assume no minor children or disabilities to contend with, which would add more wrinkles to the analysis.)
In most cases, such beneficiary designations will contribute to an efficient estate transfer. But sometimes unexpected results can arise. Here are some examples.
RRSP or RRIF beneficiaries
Suppose your client names her son, Alfonso, and daughter, Maria, as beneficiaries of both the estate and a RRIF, but Alfonso predeceases the client. Also suppose Alfonso had two sons.
Since your client did not file a detailed beneficiary designation, with contingencies, with the financial institution, the full RRIF proceeds will likely go to Maria after your client dies. (Alfonso and Maria were contingent beneficiaries on the original designation, so to go beyond that would have been a third-stage designation.)
Read: When your client wants to change beneficiaries
But, if your client’s will had been drafted with the common phrasing used to pass inheritances down generations (“issue per stirpes”), the formal estate would be split evenly between Maria on one side, and Alfonso’s two sons on the other. However, the RRIF proceeds would have been considered income in your client’s terminal year. (No rollover exceptions for spouse, minor child or disabled child apply here.) This is a debt to be borne by the estate, effectively half imposed on each of Maria and her two nephews. Maria could choose to compensate her nephews for the disproportionate results, but is not legally required to do so.
Read: Estate planning for wealthy seniors
Beneficiary on pension
Compare the result if your client’s plan was a registered pension plan instead. Unlike the inclusion of RRSP/RRIF proceeds in the deceased’s terminal income, a lump-sum payment from a pension is generally taxable to the named beneficiary.
Let’s assume again a simple beneficiary designation, where Maria was the only living beneficiary. The administrator would have paid her the plan proceeds, net of withholding tax. She would then have to report the proceeds as her own income, and reconcile any remaining tax. Thus, while Alfonso’s sons may be shut out of this entitlement (at least initially, subject to their aunt’s inclination), they will not bear any of the tax liability.
Read: Pension plans gain in 2013
Estate as beneficiary?
Things get much more challenging where there are minors, disabilities, second marriages and blended families. Your clients can alleviate many of the foregoing concerns by naming the estate as beneficiary of the registered plan, coordinated with a properly drafted will.
Depending on the tax positions of the estate and beneficiaries, this could mean more or less tax to be paid. And of course, probate tax and other estate implications result.
Still, estate planning is about taking care of the people who survive the deceased. So this may be a small price to pay to achieve a much greater degree of certainty.
For more on retirement planning, read:
Tips for blended-family estate planning: IAFP
Doug Carroll, JD, LLM (Tax), CFP, TEP, is Practice Lead — Tax, Estate & Financial Planning at Meridian.