Your RRSP or RRIF Goes to the Beneficiary—Who Pays the Tax?

The tax treatment of an RRSP beneficiary at death in Canada can create a surprisingly uneven estate-planning result.

Registered retirement accounts allow Canadians to postpone tax while saving for retirement. Contributions may generate deductions, investments can grow without annual taxation inside the plan, and eligible transfers between registered plans can continue the deferral.

But the tax has generally been postponed—not eliminated.

At death, an RRSP, RRIF or locked-in retirement account may pass directly to a beneficiary while its taxable value is reported on the deceased owner’s final income tax return. Unless the beneficiary designation, will and estate liquidity have been coordinated, one person could receive the registered account while the assets intended for other heirs are used to pay much of the resulting tax.

This is why two principles matter:

Tax deferral is not tax forgiveness.

Probate bypass is not tax bypass.

What normally happens to an RRSP at death?

Unless a qualifying rollover is available, the deceased RRSP owner is generally considered to have received the fair market value of the account immediately before death.

That amount is ordinarily reported as income on the deceased’s final tax return. Because RRSP withdrawals are fully taxable as income, a large account can generate a significant liability—particularly when added to the deceased’s other income for the year.

A named beneficiary may nevertheless receive the RRSP proceeds directly. In many cases, the account does not need to pass through the estate or wait for probate before being paid.

That creates two separate questions:

1. Who receives the RRSP?

2. Where will the money come from to pay the associated tax?

The answers are not always the same.

A surviving spouse can generally continue the deferral

An RRSP does not necessarily trigger an immediate tax bill when it passes to a surviving spouse or common-law partner.

A qualifying spouse may generally transfer eligible RRSP proceeds to their own RRSP or RRIF, or use them to purchase an eligible annuity. When the rollover is completed and reported correctly, the corresponding deduction can offset the income inclusion.

For a RRIF, a spouse or common-law partner may be named as the successor annuitant. This can allow the existing RRIF to continue, with future payments reported by the surviving spouse. A spouse receiving the RRIF as beneficiary may also have tax-deferred transfer options.

This does not make the account permanently tax-free.

It continues the deferral until the surviving spouse withdraws the money, dies or another taxable event occurs. The eventual liability may therefore be delayed until the second death.

What about RRIFs, LIRAs, LIFs and LRIFs?

The same fundamental principle extends beyond RRSPs.

RRIFs: Unless a qualifying survivor arrangement applies, the deceased is generally considered to have received the RRIF’s fair market value immediately before death.

LIRAs: A locked-in retirement account holds pension money under applicable pension legislation. A surviving spouse commonly has priority to its death benefit, subject to the governing pension jurisdiction and any valid waiver.

LIFs and LRIFs: These are locked-in retirement-income arrangements that generally also meet the federal requirements for a RRIF. They therefore combine federal income-tax rules with pension-law restrictions and survivor-benefit provisions.

The terminology and survivor rules vary between pension jurisdictions. The individual’s province of employment, the pension plan’s governing legislation, marital status, beneficiary designation and any spousal waiver can all affect the result.

Locked-in accounts should therefore be reviewed individually rather than assumed to operate exactly like an ordinary RRSP or RRIF.

Where the estate-planning mismatch appears

Consider a simplified example.

A parent has a $500,000 RRIF and names one adult child as its direct beneficiary. The will leaves the remainder of the estate equally among that child and two siblings.

The named child may receive the $500,000 RRIF directly. However, unless a qualifying rollover applies, the account’s taxable value is generally reported on the parent’s final tax return.

The estate may then require a substantial portion of its remaining cash and investments to pay the tax. The assets divided under the will are reduced—even though the RRIF itself went directly to one child.

The result may be very different from what the parent intended:

• One child receives the registered account;

• The estate absorbs the immediate tax burden;

• The remaining beneficiaries inherit less;

• The executor is left managing the resulting disagreement and liquidity problem.

Federal tax legislation can make a recipient jointly liable for tax attributable to registered-plan proceeds in certain circumstances. However, relying on the CRA’s collection rights is not an estate-equalization strategy. The will and beneficiary designations should clearly reflect who is intended to receive each asset and how the resulting tax is expected to be funded.

Where segregated funds can help

Segregated funds are insurance contracts that combine market-based investments with insurance features.

When a qualifying beneficiary other than the estate is named, the death benefit may pass directly to that beneficiary. Depending on the contract and applicable provincial legislation, this can provide valuable estate-planning advantages:

• Bypassing probate and estate-administration delays;

• Avoiding probate fees where applicable;

• Paying beneficiaries more quickly;

• Preserving greater privacy;

• Providing maturity and death-benefit guarantees;

• Offering potential creditor protection in qualifying circumstances.

These can be meaningful reasons to hold registered or non-registered investments within an individual segregated-fund contract.

However, placing an RRSP, RRIF, LIRA, LIF or LRIF in segregated funds does not change the registered plan’s basic income-tax treatment.

Segregated funds may help the proceeds bypass probate. They do not make a registered retirement account tax-free.

The insurance contract determines how the death benefit is transferred. The registered status of the account continues to determine its income-tax treatment.

Probate planning and tax planning are different

Probate planning focuses on how efficiently an asset reaches its intended recipient.

Tax planning considers the income inclusion, available rollover provisions, liquidity requirements and after-tax value ultimately received by each beneficiary.

A strategy can succeed at avoiding probate while still creating a large tax liability. It can also transfer an asset quickly while unintentionally leaving the estate without enough cash to pay the final tax bill.

Both sides must be considered together.

Plan the after-tax inheritance

Beneficiary designations should be reviewed alongside the will, not separately from it.

A coordinated review should consider:

• Who receives each registered and non-registered account;

• Which assets pass through the estate and which pass outside it;

• Whether a surviving spouse or dependent beneficiary qualifies for a rollover;

• Which pension jurisdiction governs a locked-in account;

• The approximate income-tax liability at death;

• Whether the estate will have enough liquid assets to pay that liability;

• Whether the will specifies how taxes associated with outside-estate assets should be allocated;

• Whether life insurance could fund the tax or equalize inheritances;

• Whether gradual registered-account withdrawals during retirement could reduce a concentrated future liability;

• Whether a segregated-fund contract could improve the speed, privacy or certainty of the transfer.

Dividing assets equally by their stated value does not always create an equal inheritance.

A registered account, a principal residence, a non-registered portfolio and a life insurance benefit can have very different tax characteristics. Effective estate planning compares what each beneficiary is expected to receive after tax, not merely the value shown on an account statement.

Frequently asked questions

Does an RRSP pass tax-free to a surviving spouse?

Not exactly. A qualifying spousal rollover can generally continue the tax deferral when the proceeds are transferred and reported correctly. Tax is ordinarily payable when the surviving spouse later withdraws the funds or when the remaining account becomes taxable at a later date.

Does naming a beneficiary eliminate the RRSP or RRIF tax?

No. A beneficiary designation determines who receives the proceeds. It does not, by itself, eliminate the income-tax treatment arising from the registered account.

Do segregated funds avoid tax at death?

No. Segregated funds may allow proceeds to bypass probate and pass directly to a named beneficiary, but a registered segregated-fund contract remains subject to the tax rules governing its RRSP, RRIF or locked-in registration.

Are LIRAs and LIFs treated exactly like ordinary RRSPs and RRIFs?

Not completely. They have similar federal tax characteristics, but they are also governed by pension legislation. Spousal priority, waivers, unlocking provisions and permitted transfers can vary according to the applicable jurisdiction.

Can life insurance help address the tax liability?

Potentially. Properly structured life insurance can provide tax-free liquidity to help fund taxes, protect other estate assets or equalize inheritances. The appropriate ownership, beneficiary and funding structure should be reviewed carefully.

The bottom line

Registered retirement plans offer powerful tax deferral during life and may allow that deferral to continue through a qualifying spousal rollover.

Eventually, however, the deferred tax generally becomes payable.

Beneficiary designations and segregated funds can help assets pass efficiently, privately and outside probate—but they do not erase the registered-plan tax liability.

The objective is not simply to name beneficiaries. It is to coordinate the registered accounts, locked-in plans, will, projected taxes, estate liquidity and insurance so the family receives the after-tax inheritance that was actually intended.

If you would like to review how your registered accounts and beneficiary designations fit within your broader estate plan, Delta Creek Financial Advisors can help identify potential gaps and coordinate the financial-planning pieces with your legal and tax professionals.

Independent Advice. Built Around Your Life.

Book A Meeting

This article is provided for general information only and is not intended as legal, tax or pension advice. Tax treatment, probate requirements and locked-in pension rules depend on individual circumstances and the applicable jurisdiction. Clients should obtain advice from qualified legal and tax professionals before implementing an estate-planning strategy.

Official resources

• Canada Revenue Agency: Death of an RRSP annuitant
  https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4177/death-rrsp-annuitant-a-prpp-member.html

• Canada Revenue Agency: Death of a RRIF annuitant
  https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4178/death-a-rrif-annuitant.html

• Canada Revenue Agency: Amounts paid from an RRSP or RRIF upon death
  https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/transferring/amounts-paid-rrsp-rrif-upon-death-annuitant.html

• Financial Services Regulatory Authority of Ontario: Locked-in accounts
  https://www.fsrao.ca/consumers/pensions/events-may-affect-your-pension