Registered pension plans (RPP) and RRSPs share many similarities. Both are used as tax-deferred vehicles to provide future benefits during retirement. However, when an RPP plan member or an RRSP annuitant dies, there can be surprising tax differences. Knowing and understanding these differences can go a long way to eliminating poorly timed surprises at death.
Lump sum at death
When an RPP plan member dies before retirement, a lump sum may be available to named beneficiaries or the estate. When the plan member is already retired, a lump sum may still be available if the plan member dies during a guaranteed period. Guaranteed periods are typically available for five, 10 or 15 years.
When an RRSP annuitant dies, the value of the RRSP can be paid as a lump sum to a named beneficiary or the estate. So far, so similar.
For tax purposes, the default treatment is different. An RPP lump sum payment is taxable to the recipient when a plan member dies: the beneficiary or estate would report the lump sum as taxable income in the year it is received. When this lump sum payment is made, the RPP plan administrator must withhold income tax at source, reducing the payment to the recipient. Finally, the RPP payment and income tax deducted are both reported to the recipient on a T4A in the year of receipt.
For an RRSP, the lump sum value at death is taxable to the deceased annuitant. This taxable amount is reported on the deceased’s final tax return. However, no tax is withheld on the lump sum payment of the RRSP made to the beneficiary or estate. The payment amount is reported on a T4RSP in the name of the deceased annuitant.
There are exceptions to the default treatments for both plans.
When an RPP’s beneficiary is the spouse or common-law partner of the deceased, the survivor can transfer the pension benefit to their own RPP, RRSP or RRIF. Such a transfer can be completed on a tax-deferred basis, with no immediate adverse tax consequences for the spouse or common-law partner. When an estate receives an RPP lump sum, which it allocates or pays to an estate beneficiary, such income is taxable to the beneficiary and is a deduction against the estate’s income. This may lead to a tax refund in favour of the estate for part or all of the
withholding tax on the RPP. Such a refund would be paid to the beneficiaries of the estate in accordance with the will.
The exceptions for an RRSP are called “qualified beneficiaries.” Qualified beneficiaries include the deceased’s:
- spouse or common-law partner;
- financially dependent child or grandchild with physical or mental impairments; and
- financially dependent child or grandchild.
For qualified beneficiaries, the amount from the RRSP can be taxable in their hands. However, options are available to defer tax. For a spouse or financially dependent disabled child or grandchild, the inherited amount from the RRSP can be transferred to their own RRSP, RRIF, pension (i.e., a Pooled Registered Pension Plan or Specified Pension) or used to buy an annuity.
For a financially dependent minor child or grandchild, the RRSP proceeds can be used to purchase an annuity with a term equal to 18 minus the beneficiary’s age. The beneficiaries need to make their choices by Dec. 31 of the year after the year of death.
For a financially dependent adult child who is not disabled, such as a university student, there is no rollover option.
Lastly, it may be possible for the deceased and the qualified beneficiary to share the tax liability, with each claiming part of the RRSP as taxable income. This requires coordination between the estate’s legal representative and the qualified beneficiary in order to complete the appropriate joint filing requirements.
Disabled beneficiaries have an additional option to transfer an RRSP or RPP amount to their own RDSP. This rollover is also tax deferred. The amount that can be transferred to an RDSP is limited to the $200,000 RDSP contribution limit less contributions made to date. Lastly, such rollovers are not eligible to receive the Canada Disability Savings Grant (CDSG).
Finally, if the beneficiary of an RPP or RRSP is a non-resident, this doesn’t necessarily eliminate Canadian tax on the amount received by a non-resident beneficiary. Recall that an RPP is taxable to the recipient and such taxes must be withheld at source. Non-resident withholding tax is no exception and must be withheld in these circumstances. For an RRSP, only the portion of the payment to the beneficiary that would have been taxable if they were a Canadian resident is subject to non-resident withholding tax.
While RPPs and RRSPs may seem like similar investments, their tax treatment at death has important nuances. Understanding them can better prepare your clients and their future beneficiaries, and minimize unpleasant tax surprises.
Curtis Davis , FMA, CIM, RRC, CFP, is senior consultant, Tax, Retirement & Estate Planning Services, Retail Markets at Manulife.