TaxMatters@EY: Family Wealth Edition – April 2023

Jill-Cathrin Heinze, London, Gael Melville, Vancouver, and Jennifer Chandrawinata, Toronto

Registered retirement savings plans (RRSPs) are tax-favoured investment vehicles used to save money for retirement. Income earned in an RRSP is usually not taxable until funds are withdrawn from the account.

The owner of an RRSP account, who is entitled to receive a retirement income under the plan, is referred to as the annuitant.

While RRSPs are intended to provide us with financial security in our retirement years, it is important to also consider and plan for the tax implications that may arise in the event of an untimely death. If your RRSP’s value is significant at the time of your death, an unexpectedly large tax liability may result. However, you may be able to plan around this if you intend the funds to go to your surviving spouse or common law partner, or to a financially dependent child or grandchild.

A spousal RRSP allows the annuitant’s spouse or common law partner to contribute to the annuitant’s RRSP up to the spouse’s or common law partner’s contribution limit. For the purposes of this article, we focus on individual RRSPs only.

Phases of an RRSP

An RRSP has two phases: the accumulation phase and the retirement income phase. An RRSP in the accumulation phase is referred to as an unmatured RRSP; an RRSP in the retirement income phase is called a matured RRSP.

An unmatured RRSP gives the annuitant the flexibility to make contributions and withdrawals until the RRSP matures. Once the RRSP matures, it begins to pay retirement income to the annuitant. The latest time a plan can mature is December 31 of the year the holder celebrates their 71st birthday. This is the final year for making a contribution, assuming there is sufficient contribution room remaining.

When an RRSP matures, the annuitant has three options:

• Transfer all or part of the RRSP assets to a registered retirement income fund (RRIF) with no immediate tax consequences arising on the transfer
• Use all or part of the RRSP funds to buy an annuity with no immediate tax consequences arising on the purchase
• Make a taxable withdrawal of any remaining funds from the RRSP account

Under the first two options, the annuitant will begin to receive taxable payments on a regular basis, but will benefit from a continued tax deferral on the unpaid amount in the RRIF account or annuity.

What are the tax consequences when the annuitant of an unmatured RRSP dies?

In most situations, the fair market value on the date of death must be included in the annuitant’s income in their final tax return.¹ The financial institution administering the RRSP is required to issue a tax information slip showing the plan’s value at the date of death.²

The deceased annuitant’s legal representative may be able to claim a deduction from income for an RRSP contribution made in the year of death. A deduction may be claimed if either the annuitant made a contribution before the date of death or the deceased’s legal representative makes a contribution to the surviving spouse’s or common law partner’s RRSP.³

Depending on the value of the RRSP assets at the date of death and the amount of any RRSP contributions made in the year of death, the required net income inclusion may result in a significant tax liability on the deceased’s final return.

Is there any further tax deferral available?

It’s possible to avoid the income inclusion arising on the date of death and continue to defer tax on the RRSP assets where the plan beneficiary is a qualifying survivor.

A qualifying survivor in relation to the deceased annuitant is one of the following:

• A surviving spouse or common law partner
• A financially dependent child or grandchild

Under the Income Tax Act, a child or grandchild may be considered to have been financially dependent on the deceased annuitant if they were living with the annuitant and either:

• Had net income for the taxation year preceding the year of death that was no more than the basic personal amount.
• Were financially dependent due to physical or mental infirmity and had net income for that preceding taxation year that was no more than the basic personal amount plus the disability amount.⁴

The amount distributed from the deceased annuitant’s RRSP to a qualifying survivor is referred to as a refund of premiums^.5 This amount reduces the amount required to be included in the deceased’s final return, and is instead treated as income of the qualifying survivor.⁶ However, the qualifying survivor can offset this income inclusion by undertaking an eligible tax-deferred transfer, as explained below.⁷

Surviving spouse or common law partner beneficiary

A surviving spouse or common law partner who is designated as the beneficiary of the deceased’s RRSP under the RRSP contract is able to transfer the funds to another registered plan under which they are the annuitant, or use the funds to purchase an eligible annuity for themselves.

Acceptable registered plans include an RRSP (provided the surviving spouse or common-law partner is under the age of 72), a pooled registered pension plan (PRPP), a specified pension plan (SPP) and a RRIF.⁸

The transfer or purchase must occur in the year the refund of premiums is received or within 60 days after the end of the year. If the conditions for an eligible transfer or purchase are met, the surviving spouse or common-law partner will report both an income inclusion and a deduction on their personal tax return for the year in which they received the refund of premiums, resulting in a tax-deferred rollover of the RRSP’s value.

Financially dependent child or grandchild beneficiary

A tax-deferred rollover is also available if the plan beneficiary is a financially dependent child or grandchild. In the case of a child or grandchild who was financially dependent by reason of a physical or mental infirmity, the RRSP amount received as a refund of premiums may be contributed to an RRSP, PRPP, SPP, RRIF or registered disability savings plan (RDSP) under which the child or grandchild is the annuitant or beneficiary, or may be used to purchase an eligible annuity.

If you’re considering an RDSP, remember that the lifetime contribution limit of an RDSP is $200,000.⁹ If the child or grandchild is not dependent due to a physical or mental infirmity, a rollover of the RRSP amount is only available if the child or grandchild is under the age of 18 since the RRSP amount may only be used to purchase an eligible annuity for a period of not more than 18 years minus the child’s or grandchild’s age at the time of purchase. For example, if the child or grandchild is 17 years old, the annuity period can’t be more than one year.

The rollover must occur during the year the refund of premiums is received or within 60 days after the end of the year. If the conditions for an eligible rollover are met, the child or grandchild will report both an income inclusion and an income deduction.

No designated beneficiary

If there is no specific RRSP beneficiary designated under the deceased annuitant’s RRSP contract, the RRSP funds are paid to the deceased’s estate.

If one of the beneficiaries of the estate is a qualifying survivor, the trustee and beneficiary may jointly elect for all or a portion of the RRSP funds to be treated as having been received by the qualifying survivor as a refund of premiums. This ensures that the RRSP value is included in the qualifying survivor’s income tax return instead of in the deceased’s final tax return, and the qualifying survivor may be able to complete an eligible tax-deferred transfer of the funds (as described above).

The portion not designated as a refund of premiums must be included as income in the deceased annuitant’s final return. The election is made using Form T2019, Death of an RRSP Annuitant – Refund of Premiums, and signed copies must be included with the beneficiary’s income tax return in the year of payment and with the deceased annuitant’s final return.

What are the tax consequences when the annuitant of a matured RRSP dies?

The deceased annuitant is generally required to report the total fair market value of their plan assets at the date of death as income on their final return.An exception to this income inclusion rule is if the deceased’s spouse or common-law partner is named the beneficiary or successor of the account. The plan contract or the will can designate the annuity payments from an RRSP to continue being paid to the deceased’s spouse or common law partner as successor annuitant. This ensures the payments are taxable over time in the hands of the successor annuitant instead of as a lump sum in the deceased annuitant’s final return.

If the plan beneficiary is the estate, and the deceased’s spouse or common law partner is the estate beneficiary, a similar exception is available. The legal representative may jointly elect with the spouse or common law partner to continue to have the annuity payments paid to the spouse or common law partner as successor annuitant instead of reporting the total fair market value of the plan on the deceased’s final return. The annuity payments received by the spouse or common law partner will be taxed as income at their marginal tax rate.

If the matured RRSP has multiple beneficiaries that include the deceased’s spouse or common law partner, the portion the spouse or common law partner is not entitled to receive will generally be taxable on the deceased’s final return. The legal representative may also be able to reduce the amount that has to be reported in the deceased’s final return if all or a portion of the plan assets are paid from the matured RRSP to the deceased’s financially dependent child or grandchild. In these circumstances, similar options for a tax-deferred rollover of the plan assets are available to the financially dependent child or grandchild.

A distribution from the plan to a beneficiary who is not a qualifying survivor is not taxable in the hands of the beneficiary since it was already included in the deceased’s income in the final return.

Are there tax consequences for income earned or changes in the value of the plan between death and distribution?

After the annuitant dies, the RRSP account continues to earn income on a tax-deferred basis until the earlier of the time when the plan assets are distributed and the end of the calendar year following the year of death. The period from the date of death until the end of the following calendar year is known as the exempt period.

If the fair market value of property in the plan decreases between the date of death and the distribution date, the difference between the fair market value income inclusion and the value paid out to the beneficiary is an allowable deduction on the annuitant’s final return. However, the deduction may be denied if the final distribution of the plan takes place after the end of the calendar year following the year of death.¹⁰

If the fair market value increases between the date of death and the distribution date, the difference must be included in the beneficiary’s or the estate’s income tax return in the year the transfer of funds is received. This will be taxed in the beneficiary’s or the estate’s hands at their marginal tax rate.

If the RRSP balance is not distributed by the end of the year following death, then income earned in a depositary RRSP is taxed on the beneficiaries’ returns, even if not yet withdrawn, as the tax deferral in the plan is lost after the end of the exempt period.¹¹ However, if the RRSP is a trusteed RRSP, the income earned after the exempt period would be income of the trust if it is not paid to the beneficiary. When the amount is paid to the beneficiary, the amount is reported as a tax-paid amount — that is, it will not be subject to tax a second time when distributed to the beneficiary.¹²

Looking ahead

When an RRSP holder dies without leaving instructions for their account, it can lead to a considerable tax bill for the estate.

Review your plan’s beneficiary designation and your will with your EY advisor or another professional advisor so your heirs can use the available tax-deferral opportunities.

For more tax tips relating to RRSPs and estate planning, see chapters 11 and 12 of Managing Your Personal Taxes: a Canadian Perspective 2022-23.

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Tax Alert 2023 No. 11 – New transparency register requirements in Ontario

Tax Alert 2023 No. 12 – Québec budget 2023‑24: highlights

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Tax Alert 2023 No. 14 – New Brunswick budget 2023‑24

Tax Alert 2023 No. 15 – Saskatchewan budget 2023‑24

Tax Alert 2023 No. 16 – Ontario budget 2023‑24

Tax Alert 2023 No. 17 – Newfoundland and Labrador budget 2023‑24

Tax Alert 2023 No. 18 – Nova Scotia budget 2023‑24

Tax Alert 2023 No. 19 – Federal budget 2023-24: highlights

Tax Alert 2023 No. 20 – Federal budget 2023-24

Summary

For more information on EY’s tax services, visit us at https://www.ey.com/en_ca/tax. For questions or comments about this newsletter, email Tax.Matters@ca.ey.com.  And follow us on Twitter @EYCanada.