Is my willed RRSP taxed?

This short question, asked by a reader, has a complicated answer.

First of all, let's look at the fact that the reader is asking about a "willed" RRSP. When you set up an RRSP, you have the opportunity to name a beneficiary. If you have done so, and most people do, the RRSP is not controlled by your will. It's controlled by the beneficiary designation you made when you set it up. This means that the RRSP goes to whoever was named at the time, regardless of what it says in the will.

So why would an RRSP be covered in the reader's will?

It's not impossible. It could be that the beneficiary the reader named is his estate. It could also be that the beneficiary named in the RRSP has already passed away. In a case like this, the RRSP proceeds are paid into the estate and, like everything else in the estate, are distributed according to the will.

It could also be that when the reader was making his will, he changed his mind about who should be the beneficiary of his RRSP. He could be using his will to change the named beneficiary. This is possible, but I generally advise clients who want to make a change like this to go right to the bank or financial advisor and have the change made on the RRSP itself. There is always a chance that a change made in a will is not specific enough to be effective, particularly in home-made wills. There is also a significant risk that the financial institution is never advised of the change and pays out the proceeds to the person who was named in the first place.

In any event, let's assume that the RRSP is properly governed by the will. I would make a further assumption that the person named in the will to receive the RRSP is not the reader's spouse. After all, since the reader could roll the RRSP to his spouse on a tax-deferred basis by naming her on the RRSP itself, it would make absolutely no sense for him to have the RRSP paid to the estate, have the tax paid and then have his spouse receive the net amount through the will.

If the reader's RRSP is paid to his estate, then yes it will be taxed. Taxation will be based on the idea that the reader cashed out his RRSP one minute before he died, and all the money cashed out is taxable.

Keep in mind that the tax hit doesn't happen just because the RRSP goes into the estate. It's the choice of beneficiary that is important. For example, if the same reader changed his beneficiaries on his RRSP to his two children and the proceeds were paid to them directly, there would still be tax payable. And the tax would be payable by the estate, not the children. As many of my clients grumble to me on occasion, the tax man gets you one way or another. However, that's the nature of RRSPs and the reason that TFSAs are becoming so popular.

A person can roll over his or her RRSP on a tax-deferred basis to his or her spouse. He or she can't roll it over tax-deferred to his or her children except in very limited circumstances where the child is financially dependent.

It's always a good idea to talk over the tax implications of your RRSP beneficiary designations with your estate planning lawyer or your accountant. At that point you get to move past the general tax information that's available, and find out about your own specific situation.