Rotten RRIF Taxes Revisited

May 4, 2018

In the world of wealth management there are some topics that never get old and can not be overstated.  One such thread concerns the treatment by Revenue Canada of remaining registered account balances when a single individual passes away.  I have called this Canada’s stealth estate tax, but for today let’s just call it a rotten tax and one that is probably the least fair in the country.

Let us begin with a bit of a refresher on how the tax code works when we die.  First, there can be more than one tax return that gets filed when someone expires, depending on the person’s situation.  If you are the executor a person’s estate you will be responsible for ensuring that all taxes of the individual are paid, including those for prior years if the individual did not file.  A tax professional and estate lawyer will walk you through exactly what the tax filing responsibilities are, but for now we will limit our focus to the treatment of registered accounts like RRSPs and RRIFs.

 

 

On a person’s death, Revenue Canada mandates the value of all such accounts be included in income, unless a spouse, common law individual or financially dependent child or grandchild is entitled to these amounts.  A market valuation is taken of these accounts on the day of death and this information forms part of the reports required. It is possible to transfer amounts to the stated beneficiaries, in which case they be taxed in their hands (unless it is transferred into their own tax-deferred plans). This can happen even if they are not named beneficiaries on the plans, but simply in the will. You may also be able to roll amounts from the deceased person’s registered accounts into a Registered Disability Savings Plan (RDSP) for an infirm child or grandchild that is financially dependent.

Let’s assume that there are no beneficiaries where the amounts in the registered accounts can be transferred to.  What then is the potential additional tax hit to the estate? For illustration purposes we will assume the deceased is a resident of Ontario. Based on current rates, if an individual has taxable income in excess of $220,000 then the combined marginal tax rate will be 53.5%.  Note, this would include any other taxable income the person would receive in the year of his or her passing, such as CPP, OAS or pensions. Therefore, if the remaining value of the RRIF at death was in the neighbourhood of $200,000 the top rate would most likely kick in.

 

 

Remember, this is a marginal rate and not the average effective tax rate.  For example, while income over $220,000 is taxed at 53.5%, tax on the total amount would work out to about 37%.  Still, the larger the remaining balance in the RRIF the higher the taxable income and the average rate would climb.  For example, if taxable income was $500,000 the average rate would come to about 46%. In other words, the deceased is writing a cheque north of $236,000 to the tax man for the pleasure of passing away.

Some may say that this is an unlikely scenario, but if the individual had been a good saver, maxing out his or her RRSP during their work life and, unfortunately, died prematurely then it is not unlikely at all.

Again, the executor will be responsible for making sure all taxes are paid and this could become an issue if indeed there dedicated beneficiaries on the registered accounts.  Since these monies pay outside of the estate, this means if there are not sufficient funds inside the estate to pay the additional taxes then CRA will ultimately go to the beneficiaries for payment.  Given that it can take quite a while for the tax filing and review to take place, it is possible that beneficiaries may have spent their shares.

Except for the extreme public altruists, there is a wide consensus that this tax treatment is a problem. Assuming that the current government or future governments will change it is naïve.  Considering the demographic trends this is one of the biggest tax win falls in history.  And not creating an RRSP in the first place is not a solution either.  Again, there are ways to deal with this and it just requires careful strategic thinking to minimize it.

 

 

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