Here is a typical scenario: You attend at your bank to set up a Registered Retirement Savings Plan (RRSP) or a Tax Free Savings Account (TFSA). You are presented with a pile of forms to complete as part of the account opening process. One of those forms is called a Beneficiary Designation Form and it allows you to name a person or several persons who will be entitled to the proceeds of the RRSP or the TFSA on your death. Your banker tells you that if you designate a beneficiary directly with the bank, then the RRSP or the TFSA will pass outside of probate. It’s not clear to you exactly what this means, but you complete the form anyway, designating your spouse as the primary beneficiary and your three minor children as alternate beneficiaries. You’ve just made one of the most common mistakes I see in my practice! In this blog post, I will discuss beneficiary designations in respect of registered accounts and life insurance policies and the most common mistakes to avoid.
Failing to Name a Beneficiary. If you designate a beneficiary on your registered accounts (e.g. RRSP, RRIF, TFSA) and life insurance policies, the plan provider will cut a cheque directly to the designated beneficiary upon receipt of proof of death. In other words, the plan proceeds never pass through your estate (meaning, they aren’t dealt with in accordance with the terms of your will). Since the proceeds never pass through your estate, they won’t be subject to Estate Administration Tax (“probate fees” of approximately 1.5%) when your executor applies to the Court for a Certificate of Appointment. Another advantage is that the proceeds will be paid to your named beneficiary very quickly. If you haven’t designated a beneficiary, the proceeds won’t be paid to your estate until a Certificate of Appointment has been issued, which can take anywhere from 4-16 weeks in Toronto.
Naming Minor Children. In my practice, I commonly see couples who have designated each other as the primary beneficiary and their (now) minor children as alternate beneficiaries. There are several pitfalls with this planning. First, minors cannot deal with their own property. If a minor is designated as the beneficiary of a life insurance policy or a registered plan, the proceeds must be paid into Court to be administered by the government until the child reaches the age of 18 years, at which point the full amount of the proceeds will be paid to the child. Most (but not all!) declaration forms provided by banks and insurance companies allow you to name a trustee where one of the beneficiaries is a minor. However, most of these forms are silent on the trustee’s powers, thereby creating what is known as a “bare trust”. This means that the trustee may hold and invest the funds but cannot pay out any amount to or for the minor’s benefit including, for education, health care (hello orthodontics!), extra-curricular activities, etc. As well, the trustee clause on these forms is always limited to the age of majority. So, like funds that are paid into Court, once the minor reaches the age of 18, they are entitled to receive all of the funds.
Failing to Consider Trusts for Minor Children. This is a corollary to Point #2. It is possible to create a “true trust” for minor beneficiaries so that while the trustee is holding and investing the trust funds, he has the power to pay out income and capital for the benefit of the beneficiary. In addition, the trust terms can direct the trustee to hold the funds beyond the age of majority so that funds aren’t paid to the beneficiary until he reaches a certain age (e.g. 25 years) or ages (e.g. staged distributions). However, you cannot do this by way of a bank designation form. You need to have a lawyer create a special trust in your will or in a separate trust document.
Naming a Child with Special Needs (or a Dependant Adult). All of the concerns with respect to naming a minor child apply here with some extra cautions. If you name a beneficiary who is receiving government support such as ODSP (Ontario Disability Support Program) payments, the inheritance could push the beneficiary over the allowable income and asset limits, which would disentitle him to government benefits (which include not only income but also drug benefits and disability related services and supports). Again, a lawyer can draft a special trust so that the proceeds by-pass the estate (saving your estate probate fees) but are protected in a manner that doesn’t jeopardize government supports.
Ignoring Spousal Rights. You can leave your registered plans and life insurance policies to whomever you wish. However, if a married spouse believes that he has received less on death than he would have on divorce, he can bring an election under the Family Law Act for equalization of net family property. This is a complicated area of the law which is beyond the scope of this post, but suffice it to say that unless you want to subject your estate (and your executor and beneficiaries) to protracted litigation, you must consider spousal rights (and the rights of dependants) in structuring your overall estate plan.
Ignoring Tax Consequences. When you pass away, you are deemed to have disposed of your RRSP/RRIF immediately before death, with the result that the full amount of the RRSP/RRIF is brought into income in your terminal return. In other words, income tax will be payable on the value of the RRSP/TFSA at death. There are tax deferral opportunities available for spouses (legal or common law) and dependant children or grandchildren. This is a topic for another post. For now, the important point to note is that there can be a “mismatch” between the benefit and the burden. In the event the deemed disposition of an RRSP/RRIF results in a tax burden to the deceased owner, the tax burden will be borne by the residuary beneficiaries of the estate (who will receive whatever is left after the payment of debts and taxes) and not the beneficiary of the RRSP/RRIF. When drafting a will or creating an overall estate plan (which includes beneficiary designations), it is important to determine whether the tax liability associated with a particular asset rests with the beneficiary of that asset (or your other beneficiaries) and whether this result is equitable given your overall objectives.
Failing to Update Beneficiary Designation Forms. A beneficiary designation in a will only applies to those plans in existence at the date the will is executed. This is the one exception to the rule that the will speaks from the date of death. Practically speaking, if your will contains a beneficiary designation, you should either re-execute (“republish”) your will if you acquire new registered plans (e.g. you move your registered accounts to a new institution or you convert your RRSP to a RRIF) or sign a new beneficiary designation form with the plan provider. Likewise, if you revoke a will containing a beneficiary designation (or its is revoked by “operation of law”), you must either execute a new will with a beneficiary designation or sign a new beneficiary designation form. This will be crucial where the beneficiary designation is part of an overall estate plan.
Failing to Submit Beneficiary Designation Forms. For this point, I have an example from a client file. I recently acted for the mother of a young man who died unexpectantly and without a will. His only assets were a bank account held jointly with his mother and a group life insurance policy through work. While going through the deceased’s papers, his family found a beneficiary designation form for the life insurance policy that had been signed by the deceased and which designated his mother as the sole beneficiary. When my client asked the insurer to pay out the proceeds of the policy to her as beneficiary, they advised her that there was no beneficiary designation on file. As a result, they were required to pay the proceeds to the estate. Since there was no will, the mother was advised to apply to the Court for a Certificate of Appointment of Estate Trustee without a Will (a long and costly process). The good news is that I was able to convince the insurer to pay out the proceeds to the mother without the Certificate, but it could have gone the other way (if the policy was for a higher amount, for example). The takeaway is that it’s not enough to simply complete the form, it needs to be submitted to the plan provider (ideally, with an acknowledgement of receipt).
Do you have an RRSP, RRIF, TFSA or life insurance policy? Check your beneficiary designations, and call me if you want to discuss how they fit into your overall estate plan.