UNINTENDED CONSEQUENCES OF BENEFICIARY DESIGNATIONS

 
Naming your spouse as a beneficiary of your RRSPs, RRIFs, LIFs and LIRAs is usually a good idea as these assets can rollover on a tax deferred basis only to your spouse or common law partner. However, in cases where you may not be married, your spouse may have passed away or you may simply wish to name your children as beneficiaries of your registered assets, the choice is not as straightforward and you need to take tax and estate planning implications into account.

In such cases, you may opt (as most people do) to name your children as beneficiaries of both your estate and all of your registered plans. By doing this you can avoid probate tax on the registered plan and keep it out of the reach of your creditors at death, speed up the release of the proceeds and possibly reduce estate administration costs.

While in most cases such beneficiary designations can result in an efficient estate transfer, sometimes, unexpected consequences can result. Let’s consider an example.

Suppose Leo names his son, Michael and his daughter, Michelle, as contingent beneficiaries of both his estate and his RRIF. Leo’s wife, Maria, who was the primary beneficiary of his estate and his RRIF, passed away last year and before Leo could get around to updating his beneficiary designations, his son, Michael was killed in a car accident and therefore predeceased his father. Michael had two daughters of his own. Leo does not have a will.

Since Leo did not file a detailed beneficiary designation with his financial institution, the full proceeds of the RRIF will likely go to his daughter, Michelle, after he dies. On the beneficiary form that Leo completed he had named his wife as his primary beneficiary and Michael and Michelle as his contingent beneficiaries, so to go beyond that designation would have required a third-stage designation and most financial institutions do not even have a form to provide for that.

If Leo had a will, it could have contained the common phrase used to pass inheritances down generations (“issue per stirpes”) and accordingly his estate would have been split evenly between his daughter Michelle and Michael’s two daughters.  However, the RRIF proceeds would have been fully taxable as Leo’s income in the year of his death (the proceeds of a RRIF can only be rolled over on a tax deferred basis to a spouse, minor child or disabled child). The taxes would have to be paid by the estate and would effectively be imposed half on Michelle and half on her two nieces. Since there was no will in this case, Michelle could choose to compensate her nieces for the disproportionate results, but is not legally required to do so. Having a will could ensure that Leo’s wishes would be fully implemented after his death and his estate distribution would be fair and equitable to his children and their descendants.

This also goes to show that you should update your beneficiary designations as soon as possible to avoid unintended consequences.

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