This blog was written by Isabelle Cadotte – Estate and Trust Consultant with Scotia Wealth Management
Beneficiary designations on registered accounts and pension plans (RRSPs, RRIFs, TFSAs, etc.) and life insurance policies are a double-edged sword when it comes to estate planning.
They are simple to implement – a designation can be made by Will or with a form supplied by the financial institution or insurance company. They also offer many advantages, the first and foremost of which being that the beneficiary will receive the asset almost immediately after death, without having to wait for the estate to be fully administered. This results in less administrative work for the Executor and is particularly useful for beneficiaries who were financially reliant on the deceased owner. Likewise, a charity can be designated as beneficiary, allowing for a legacy to be established rapidly and smoothly. In most cases, the beneficiary does not bear the financial burden of any tax liability on the asset. And, since the asset does not form part of the estate, it can be shielded to an extent from claimants and creditors of the estate. With the exception of Quebec, designations can be made revocable or irrevocable, providing either flexibility for a future change in circumstance or certainty of outcome. Many issuers allow both primary and contingent beneficiaries to be named, and the asset can be split in proportions amongst multiple beneficiaries.
But, without proper planning, unintended consequences can result and often give rise to protracted disputes. Unintended consequences like in Morrison Estate (Re), 2015 ABQB 769, where one of the deceased’s 4 children was designated as the sole beneficiary of a $73,000 RRIF and refused to help pay the estate’s RRIF tax bill or contribute the asset to the estate to satisfy the Will gifts to the deceased’s grandchildren. The grandchildren would have received nothing without the court’s intervention.
Disputes like in Moore v. Sweet, 2018 SCC 52 , where the ex-wife and the new common law spouse of the deceased went all the way to the Supreme Court of Canada over a $250,000 life insurance policy whose premiums had been paid for by the ex-wife on the basis of a verbal understanding with the deceased that the ex-wife would be the sole beneficiary of the policy. The deceased changed the designation to his new spouse, leaving the ex-wife out thousands of dollars paid in insurance premiums and legal fees to pursue her claim.
To ensure the desired outcome is achieved, consider the following before making a change to a beneficiary designation:
1. Estate debts and expenses
In order for beneficiaries of the Will to receive their inheritance, the Executor must first ensure all debts, taxes and expenses of the estate have been paid. The value of an asset with a beneficiary designation on file will not be available to pay estate debts or expenses as the asset does not form part of the estate. Instead, the value will be paid outright to the designated beneficiary. That beneficiary has no obligation whatsoever to return any part of the asset to the estate for payment of estate debts nor are they required to share the asset with the Will beneficiaries.
2. Income tax on RRSPs and RRIFs
Clients often assume that their RRSP or RRIF will be treated in the same way for income tax purposes during their lifetime and after death. Not so.
During life, whenever an amount is withdrawn from an RRSP or RRIF, a percentage of the withdrawn amount is withheld by the financial institution for payment of taxes: the owner receives the net, after-tax amount of the withdrawal. Conversely, at death, the institution does not withhold any sum towards the tax liability: the beneficiary receives the full cashed-in value and the estate will later get a tax bill (unless the transfer is eligible for a tax-deferred rollover to a spouse, a minor child, disabled adult child or other eligible recipient). The designated beneficiary has no legal obligation to contribute any part of the asset towards the estate tax bill. So, if the beneficiary designation is different from the beneficiaries named in the Will, this could lead to a situation like Morrison Estate.
Though the Income Tax Act allows the Canada Revenue Agency to go after the sole beneficiary of an RRSP or RRIF when the estate is insufficient to pay all of its tax bill – as they did in O’Callaghan v. The Queen, 2016 TCC 169 – it is more prudent to do proper advance planning to avoid this scenario. It is not enough to simply assume the designated beneficiary will return the asset to the estate for payment of debts and taxes and for distribution to the Will beneficiaries. The beneficiary designation should reflect the actual intention of the owner.
3. Naming a trustee for minor beneficiaries
Since minors cannot hold property in their own name, it is important to name an adult or trust company as trustee for any minor beneficiary. Appointing a trustee in a Will or setting up a testamentary trust in a Will does not necessarily translate over to the investment itself so a trustee should be named on the form as well. If the intention is to hold assets in trust for a minor past the age of majority, the asset may need to be directed to the minor through the Will to ensure testamentary trust provisions apply to the asset as well.
4. Revoking a Will or updating a designation
Unless a designation is made irrevocable, it can be changed by the owner at any time either by their Will or with a form supplied by the financial institution or insurance company. Consider the following technicalities when deciding how to proceed:
- Revoking a Will with a beneficiary designation contained in it revokes that designation and it does not revive a prior beneficiary designation – a new designation must be made when updating a Will;
- If nothing is specified (e.g., the designation form is never completed or there is no relevant clause in the Will) or all beneficiaries have predeceased, the asset will revert to the estate – the portion of the asset that was designated for a predeceased beneficiary will not be paid to the beneficiary’s estate;
- Making a new designation by any method revokes any prior designation made by any method;
- Using the form method ensures the financial institution has notice of the change in designation whereas a Will designation may not be known until the Will is read;
- The financial institution is not required to investigate whether or not a subsequent designation has been made and is not liable if they make a payment to the last designated beneficiary on their records – a subsequent designation by Will might not be acted upon if the institution is not made aware in time that it exists;
- Specialty wording is required to make an effective designation in a Will, and the asset must be described with enough detail for it to be identifiable;
- In Alberta, marriage does not necessarily invalidate a prior designation made by form – update your Will and beneficiary designations when a change in life circumstances warrants it.