Throughout our working lives we can reduce our annual tax bill by making RRSP contributions. Withdrawals from registered accounts are generally considered taxable income in the year the withdrawals are made.
Over time your account may have generated different types of income including dividend income, interest income and capital gains. All of this income would have been deferred.
An important item for people to understand is the tax consequences when withdrawals are made. All withdrawals are considered ordinary income taxed at your full marginal tax rate regardless of the original type of income.
For many people, the more important item to factor in is the tax consequences upon death. Effective January 1, 2020, a new top personal income tax rate was introduced in B.C. This increase essentially adds an additional 3.7 per cent tax to many estates final taxes.
When a registered account owner dies, the total value of their registered account is included in the owner’s final tax return. The final tax return is often referred to as a terminal tax return. The proceeds will be taxed at the owner’s marginal tax rate. The highest marginal tax rate is currently 53.5 per cent (British Columbia 20.5 per cent and federal 33 per cent).
An individual who has a $1,000,000 registered account may have to pay $535,000 of that amount to the Canada Revenue Agency in taxes. If the estate is named as the beneficiary and the account is subject to probate then this must also be paid out of the estate.
As of August 7, 2019, there are no probate fees in B.C. for the first $25,000, between $25,000 and $50,000 the fee is 0.6 per cent. Above $50,000, the fee is 1.4 per cent.
CRA considers you to have cashed in all of your registered accounts in the year of death. Paying nearly 55 per cent of your retirement savings to CRA is something investors should strive to avoid. There are a few situations where this tax liability can be deferred or possibly reduced.
Spouse
Registered assets can be transferred from the deceased to their spouse or common law spouse on a tax-free rollover basis provided they are named as beneficiary.
The rollover would be transferred into the spouse’s registered account provided they have one. If the spouse does not have a registered account they are able to establish one. The registered assets are brought into income on the spouse’s return and offset by a tax receipt for the same amount.
This rollover allows the funds to continue growing on a tax-deferred basis. The rollover does not affect the spouse’s RRSP contribution room.
If your spouse is specifically named the beneficiary of your RRIF account then you should designate your spouse as a “successor annuitant.” As a successor annuitant, the surviving spouse will receive the remaining RRIF payment(s) if applicable and obtain immediate ownership of the registered account on death. These assets will bypass the estate and reduce probate costs.
You should discuss all estate settlement issues with your legal advisors and financial institution to obtain a complete understanding.
Child or grandchild
Registered assets may be passed onto a financially dependent child or grandchild provided you have named them the beneficiary of your registered account.
In order to be financially dependent, the child or grandchild’s income must not exceed the basic personal exemption amount. A child that is under 18 is able to receive an income-producing annuity that pays the full amount until the child is 18.
A child of any age who is financially dependent on you is able to receive the proceeds of your registered account as a refund of premiums. This essentially means that the tax will be paid at the child’s marginal tax rate, likely to be considerably lower than your marginal tax rate on the terminal tax return.
If the child is dependent on you by reason of physical or mental disability then the registered account may be rolled over tax-free into the child’s own registered account. There are no immediate tax consequences and there is no requirement to purchase an annuity. You may want to discuss the practical issues relating to having your registered account transferred to a child with a disability.
Beneficiaries
Care should be taken when you select the beneficiary or beneficiaries of your registered accounts. If you name a beneficiary who does not qualify for one of the preferential tax treatments listed above then it could cause some problems for the other beneficiaries of your estate.
An example may be naming your brother as the beneficiary of your RRSP and your children as beneficiaries of the balance of your estate. In this example, the brother would receive the full RRSP assets and the tax bill would have to be paid by the estate, reducing the amount your children would receive.
Important points
Every situation is different, and we encourage individuals to obtain professional advice. Below we have listed a few general ideas and techniques that you may want to consider in your attempt to reduce a large tax bill:
• Pension credit — You should determine if you are able to utilize the pension tax credit of $2,000. If you are 65 or older, then certain withdrawals from registered accounts may qualify for this credit. For couples this credit may be claimed twice — effectively allowing some couples to withdraw up to $4,000 per year from their registered accounts tax-free.
• Single or widowed — Single and widowed individuals will incur more risk with respect to the likelihood of paying a large tax bill. Single and widowed individuals should understand the tax consequences of them dying as no tax deferrals are available.
• Charitable giving — One of the most effective ways to reduce taxes in your death is through charitable giving. Those with charitable intentions should meet with their professional advisors to assess the overall tax bill after planned charitable donations are taken into account.
• Life insurance — One commonly used strategy is for individuals to purchase life insurance to cover this future tax liability. The tax liability created upon death coincides conveniently with the life insurance proceeds. This would enable individuals to name specific beneficiaries on their registered account without the other beneficiaries of the estate having to cover the tax liability.
• Estate as beneficiary — If you name your estate the beneficiary of your registered account then probate fees will apply. An up-to-date will provides guidance on the distribution of your estate.
• Life expectancy — Individuals who live a long healthy life will likely be able to diminish their registered accounts over time as planned. Ensuring your lifestyle is suitable to a longer life expectancy is the easiest way to defer and minimize tax.
Individuals should ask their tax professional to estimate the tax their estate would have to pay, with the updated rates, if they were to die today. This will begin a conversation that may allow you to create a strategy that reduces the impact of final taxes on your estate and throughout your lifetime.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with the Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com
