RRSPs, RRIFs and Estate Insolvency
Many Canadians take advantage of Registered Retirement Savings Plans (RRSPs) during their income earning years, which then mature into Registered Retirement Income Funds (RRIFs) upon reaching the age of 71. The advantage from these assets in life can quickly become a disadvantage in death due to the potential tax burden that these assets can pose to the post-mortem administration of an estate that was not properly planned out by a qualified tax lawyer.
A common approach to RRSP and RRIF assets is to name individuals as beneficiaries, so that the asset may flow directly to the beneficiary, in order to provide funds to a beneficiary shortly after death. This strategy is also used to reduce assets that may be subject to probate.
In every Canadian province except Alberta and Quebec, there are progressive rate probate fees that are payable on assets that pass to the Personal Representative on death. Currently in Alberta, probate fees are no higher than $525, however in other provinces these fees can be up to 1.5% of the value of the estate.
Typically, the named beneficiary is the surviving spouse, however this is not always the case. The rollover exception is generally available where the beneficiary is a spouse (or common-law partner), a financially dependent child (or grandchild) under the age of 18, or a financially dependent disabled child or grandchild. In these cases, the tax on the asset is deferred until a future tax event occurs, such as the withdrawal of funds by the beneficiary or the death of that beneficiary.
In all other cases, the RRSP and RRIF may pass to the beneficiary, but there is a mismatch between the tax burden and the asset. Since the “deemed disposition” occurs just prior to the death of the taxpayer, the estate may be required to pay the tax due in respect of a RRSP or RRIF held by the deceased. This can cause problems when the surviving spouse passes away leaving only adult children as beneficiaries of the RRSP or RRIF.
Under the Income Tax Act, there is a “deemed disposition” of the RRSP or RRIF immediately before the annuitant’s death. This creates a taxable event unless a “rollover” exception is available. Essentially, the fair market value of the RRSP or RRIF at the date of death is included in the income of the deceased annuitant in their final or terminal tax return.
The often significant tax burden can induce a personal representative to sell estate assets at a loss in order to meet their requirement to satisfy all taxes and debts of the estate. This can lead to a diminished allocation to the residual beneficiaries of the estate, and the potential to cause conflicts between the beneficiaries and personal representative.
Furthermore, if the estate is insolvent, which may be the case due to the tax liability, the beneficiaries as well as the estate may be liable for the tax arising from the RRSPs and RRIFs. Beneficiaries may not be anticipating the potential requirement to pay tax on this gift in the future, and may use these funds to for other purposes. This could expose the beneficiary to substantial amounts of interest and penalties on the tax.
In cases where the tax burden exceeds the value of the estate, not only will the residual beneficiaries be unable to receive a distribution from the estate, but creditors, including family members who may have loaned money to the deceased, they may have limited options for recovery. Courts in Ontario and Saskatchewan have held that creditors have no right to seek repayment of the debt from the proceeds of the RRSPs in the hands of the designated beneficiary when the estate was unable to pay its debts.
In order to prevent a situation where an estate has insufficient assets to pay creditors, taxes and debts or is forced into selling assets at a loss due to the tax from a transfer of RRSP or RRIF assets, or to create a future tax event that your beneficiaries may not be prepared for, it is strongly recommended to plan ahead. Implementation of a thorough estate plan will help avoid these problems.
Invitation for Discussion:
If you would like to discuss this article in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Estate Planning group at Nerland Lindsey LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.
 See for example Slater v. Klassen Estate,  2 C.T.C. 100,  3 W.W.R. 433, 143 Man. R. (2d) 284, 2000 D.T.C. 6336, 32 E.T.R. (2d) 122 (Man. Q.B.)