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Friday, March 25, 2011

Can I name my sister as the beneficiary of my RRSP?

As I've said before, the question is never "can I?" when it comes to legal and financial decisions; it is always "should I?"

A reader asked me whether he could name his sister as the beneficiary of his RRSP. To answer this question for a customer, I'd want to know a couple of things first. I'd want to know who else is in the picture that he might name. I'd want to know what other assets were available. And I'd want to know if there was any specific reason for leaving this asset to his sister.

All of these factors work together. One outcome that is affected by the choice of beneficiary is taxation. Money put into RRSPs is not tax-free; it's tax-deferred. That means that the tax is paid when the money is taken out of the RRSP. If the reader names his sister as the beneficiary of the RRSP, tax must be paid at the time he dies and she receives the money. But if he had named his wife, the RRSP could roll over to the wife without any tax being paid.

Let's look at how this affects his estate. If he had an RRSP with $250,000 in it, and rolled it over to his wife on his death, the wife would receive the entire $250,000 and no tax would be paid. If he named his sister, on his death the sister would receive the entire $250,000. However, his estate would have to pay the income taxes on the money, which could amount to as much as 40% of the money.

This means less money for someone else in the estate. If the reader was trying to create an equal distribution among a group of people, say his siblings, he would have accidentally messed up his own estate plan.

There is always the possibility that the reader asking the question doesn't have a spouse, but if he does, he should be aware of the effect of naming his sister rather than his wife.

If the reader's goal is to give some financial help to his sister, there might be another asset that could be given to her with a better tax result. For example, he could leave a life insurance policy to his sister without triggering any tax to his estate.

When making decisions such as who should be named as a beneficiary of a specific asset, the entire estate must be looked at as a whole to make sure one decision isn't adversely affecting another.

2 comments:

  1. If the deceased is single & left his/her RRSP to two of the siblings to be divided amongst other siblings? Let say 6 more siblings.what will be the tax result. How would they minimize tax on their inheritance?

    Motherly love

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  2. Hi Motherly Love,

    May I caution anyone reading this not to leave an asset to two people "to be divided" among the others? This leaves "the others" with no enforceable legal rights at all. You'd be amazed at how often this kind of arrangement does not get carried out as planned. Please don't do it.

    Either leave the asset to all of them, or even better, leave it to your estate and make a will leaving the asset among them.

    The tax result of leaving an RRSP to siblings, whether two or eight of them, is the same. There is no rollover available so income tax on the whole RRSP becomes payable at the time the deceased died. The RRSP goes to the people named and the tax on the RRSP is paid by the rest of the estate.

    Individuals in Canada do not pay tax on money they inherit so there is no reason to try to reduce it. As for reducing the tax payable by the estate, I would recommend consulting an accountant who does a lot of tax and estate work. The paid-out RRSP funds are added to the estate's tax return as income, and the accountant can help determine which deductions, elections, losses and exemptions are available to help reduce the tax.

    Lynne

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