When it comes to estate planning, a will is undoubtedly a crucial document. However, there are downsides to distributing assets through a will, such as a probate tax that varies by province. Additionally, once your will is probated, it becomes public record, meaning anyone can look up how your assets were distributed.
To avoid these issues, certain assets can be transferred directly to a beneficiary outside your will by naming a beneficiary directly. This approach has several benefits, including potentially more money for your family, privacy, and simplicity for those involved.
The critical aspects of beneficiary designations are that funds in a plan with a beneficiary named:
- Are paid directly to the named beneficiary
- Are not part of the estate
- Are not subject to probate tax
- Are not governed by the deceased’s will
Let’s look at some assets that can be transferred directly to a beneficiary.
Life Insurance
You can name various individuals or entities as beneficiaries on your life insurance policy, including your spouse, children, dependents, another family member, a friend, or a charity. If you name your estate as the beneficiary, the death benefit will become a part of your estate, subjecting it to probate and making it public record.
However, if you name a specific beneficiary, the money goes directly to that person or entity, providing them with more money. This approach may also help prevent jealousy and tension among those named (or not named) in a will, reduce hurt feelings if someone feels left out of the will, or leave proceeds behind for someone not necessarily included in your will.
You can also name a contingent beneficiary on your life insurance policy. This person will receive the death benefit if your named beneficiary dies before you or at the same time as you do.
Registered Retirement Income Fund
A Registered Retirement Income Fund (RRIF) offers two beneficiary options: beneficiary or successor annuitant.
Successor Annuitant: Only your spouse or common-law partner can be named a “successor annuitant” of a RRIF. If you name your spouse or common-law partner as the successor annuitant, they will automatically continue to receive the RRIF payments upon your death. The RRIF essentially rolls over to them, and they don’t have to sell the assets or pay any immediate taxes. It just continues as if they took over the original RRIF. If your successor annuitant transfers the funds into their RRSP, there is no impact on their contribution room.
Beneficiary: If someone other than a spouse (like a child or a charity) is named a beneficiary, the RRIF will collapse upon the holder’s death, and the proceeds will be distributed to the beneficiary. The full value of the RRIF is considered income for the deceased in the year of their death, which means it will be subject to income tax. However, there are tax strategies and exceptions in certain cases (like if the beneficiary is a financially dependent child or grandchild with a disability).
No Designation: If no successor annuitant or beneficiary is named, the RRIF will collapse upon the holder’s death, and the proceeds become part of the deceased’s estate. As with the beneficiary scenario, the full value of the RRIF is considered income for the deceased in the year of death, subject to income tax. According to the province’s intestacy laws, the proceeds will be distributed based on the deceased’s will or, if there’s no will, they will be distributed according to the laws of intestacy, which dictate how assets are divided in the absence of a will.
Tax-Free Savings Accounts
A Tax-Free Savings Account (TFSA) allows two types of designations: beneficiary and successor holder. Only your spouse or common-law partner may be named a successor holder. If you die with this kind of designation, your TFSA continues with your surviving spouse replacing you as the account owner. Even if your surviving spouse has their own TFSA and no available contribution room, the investments in the successor account enjoy tax-free status in the hands of the new owner.
The other type of designation is a beneficiary. If you have a TFSA with a named beneficiary, then upon your death, the investments pass to the designated individual(s). Any income earned on the investments between the date of death and when the funds are transferred to your beneficiary is subject to tax. However, if your beneficiary has enough available TFSA contribution room, they could contribute the funds received to continue sheltering them from tax.
Conclusion
Beneficiary designations are an essential part of your financial strategy. By naming beneficiaries directly, you can ensure that your assets go to the right people or entities without subjecting them to probate tax or making them public record. Reviewing your beneficiary designations should form part of your regular reviews.
