It’s RRSP “season”, a term you’ll hear often in the first 60 days of any calendar year in Canada*. I’m sure you’ve seen many commercials on TV and online trying to convince you to set up or contribute to a registered retirement savings plan.
As common as RRSPs are, I’m often asked basic questions about them, so I thought I’d start with identifying a few key points.
What is an RRSP?
You probably know that RRSP stands for “Registered Retirement Savings Plan”, however many people confuse the term with a specific product.
Years ago, when interest rates were much higher, during the first 60 days of the year financial institutions would advertise GICs offered at premium interest rates. This type of marketing gave many people the impression that RRSPs were a “thing” that you buy which isn’t really accurate.
Today it’s more common for people to open up self-directed RRSP accounts and purchase not only GICs, but also mutual funds or exchange traded funds, stocks, and any other RRSP eligible investments. So, a more accurate way to look at your RRSP is to think of it as an account (or any number of accounts) that you own that has been “registered” with the Canada Revenue Agency to identify that it qualifies for special tax treatment.
The Tax Advantages of RRSPs
Most people understand there is a tax benefit to opening and saving in RRSPs, but aren’t completely aware of the three tax advantages offered:
1) Tax Deductible Contributions — when you put money into your RRSP, you get to deduct that amount from your earned income. Lowering your taxable income, lowers your taxes and may even get you a tax refund.
2) Tax Sheltered Growth — When you invest the money you’ve contributed to your RRSP, that money grows tax free. Interest earned, dividends received, and capital growth are not taxed until you withdraw funds from your account. This tax free environment dramatically increases the compound growth potential of your investments over time.
3) Tax Deferral — It is true that you don’t avoid taxes with your RRSP, you defer them to a later date. You can pull your money out of your RRSP any time (assuming your investments are cashable), but you will pay tax when you do so. If you wait until retirement to withdraw money, you’ll be taxed but you’ll likely be taxed at a lower rate than you are while working. This is because most people live on less money when they’re retired than the money they were earning while employed.
The Tax Deferred RRSP Rollover
If your spouse or partner passed away more than 6 months ago, you may already be familiar with how an RRSP can be transferred without triggering any taxes. But if you’re a very recent widow, you may be wondering what the tax implications might be, particularly if it’s a large amount of money involved.
One of the beneficial features of RRSPs, is that there is a way to pass the assets to a surviving spouse or other qualified beneficiaries (common law partner, financially dependant children), without triggering any tax. This process is called a tax-deferred “rollover”.
In practice, the rollover seemingly happens in one fell swoop, but from the CRA’s perspective there’s really 2 parts:
1) When a person dies, the value of the assets in the RRSP are deemed to have been received by the deceased as though they withdrew the entire amount out of their account. The value of the assets are then included in their income for that tax year. However, if the deceased has a qualified beneficiary, then the value of the assets are included in the income of that beneficiary. This is called a “refund of premiums” by accountants, a term that will come up again in a minute.
But, you might ask, won’t this cause a big tax bill for that beneficiary? No. This is where the 2nd part of the rollover comes in.
2) A qualified beneficiary can then take the proceeds of the deceased’s RRSP and contribute them to their own RRSP provided that they do it in the year the assets are received (or the first 60 days of the next year). They can then claim a tax deduction to offset the income that will be included in their tax return.
What if you don’t have the contribution room to allow the amount you’ve received? It doesn’t matter. In this case, qualified beneficiaries don’t need to have any contribution room in order to allow the funds to be transferred into their registered account.
Again, in most cases you’ll see the RRSP assets transferred in one move from the estate RRSP to that of the surviving spouse or other qualified beneficiary. But, when you’re on the receiving end, you’re under no obligation to have the assets transferred into you registered account, provided you don’t mind paying the tax (which may be desired if you’re in dire financial straits).
Another benefit of this rollover is the estate’s RRSP assets don’t get included in the property that must be identified when probating the will. This reduces the probate fees in provinces where the fees are based on the size of the estate. It also speeds up the transfer of assets to the desired beneficiary.
When an RRSP account is opened, you’re asked to identify a beneficiary on the account documents (except in Quebec, where named beneficiaries aren’t allowed). You can name anyone you like, it doesn’t have to be a “qualified” beneficiary, or simply put the word “estate” If you put “estate” down as the beneficiary, the RRSP assets will be distributed based on the directions written in the will, assuming there is a will. It may then have to go through probate, and there can be tax implications.
The tax-deferred rollover is a fairly easy process if the RRSP has a named beneficiary but even without one, there is a provision that makes the tax-deferred rollover possible. There are two key variables necessary. First, the beneficiary must be “qualified” and secondly, the executor has to jointly elect along with that beneficiary to treat the proceeds as a “refund of premiums” (remember that term?).
There’s a CRA form that needs to be completed and signed by both the executor and the beneficiary. That form then has to be filed with both the deceased’s and beneficiary’s tax returns. And of course, the assets have to be transferred into the beneficiary’s RRSP within the year of death or the first 60 days after.
I’ve tried to simplify this as much as possible but I know it may still seem complicated. As always, I recommend speaking with a tax professional if you have any questions. Furthermore, if the executor of your spouse’s estate is struggling with this or any issue, they should be encouraged to use professional help. Paying a little money for accurate advice could save a lot of time and money in the estate settlement process.
