How is a non-registered account taxed upon death?

So, before I get to your questions, Joe, let’s review the tax implications of various investment accounts when you die.

RRSP and RRIF taxes at death

If you leave your RRSP or registered retirement income fund (RRIF) to your spouse or common-law partner, the account can be transferred to their RRSP or RRIF on a tax-deferred basis.

When they die, the account value is reported as income on their final tax return as if the entire balance was withdrawn on the day of their death. If they have a high income from other sources that year, this can lead to a large amount of tax payable.

TFSA taxes at death

Tax-free savings accounts (TFSAs) are tax-free across the board: Income and capital gains in a TFSA are tax-free, as are withdrawals from the account.

When you die, the account is mostly tax-free as well. I say mostly because if you do not leave the account to your spouse or common-law partner, there may be some tax on the income or growth that occurs after your death. But the value of the account as of the date of your death is not taxable.

Non-registered account taxes at death

A non-registered account that is left to your spouse or common-law partner does not generally result in tax payable. The accrued capital gains can be deferred, and the account can pass to your spouse at its adjusted cost base. Effectively, it’s as if your spouse bought the investments themselves, with no deemed disposition or tax payable on your death.

An executor can elect to trigger a partial capital gain, which may be advisable if the deceased’s income is relatively low, if they have lots of deductions or credits in the year of their death, or if they have a capital loss carry-forward.

Non-registered investments left to beneficiaries who aren’t spouses, such as children, are subject to tax. The investments are considered sold by the deceased on the date of death with deferred capital gains added as income. Tax payable can be up to 27%, or possibly up to 37% if proposed capital gains inclusion rate changes are enacted.

GICs versus stocks in a non-registered account

If you buy guaranteed investment certificates (GICs), Joe, you will avoid capital gains tax on your death. But you may pay more overall tax. GICs don’t grow in value the way a stock can appreciate over time, so there’s no capital gain taxable on your death.

However, GICs are less tax-efficient on an annual basis compared to other investments. GICs are taxed annually based on the interest income earned, whereas capital gains are only 50% taxable—and only when you sell the investments. Dividends from Canadian stocks also benefit from a lower tax rate if the investments are held in a non-registered account.

GICs tend to have lower annualized returns than stocks over the long run. For example, your GICs might earn a 3% annualized return over the long run, with tax payable on that income annually. By comparison, your stocks might earn a 6% long-term return, with 2% taxable annually from dividends and 4% taxable in the future from deferred capital gains.

You will probably be better off earning a tax-efficient, somewhat tax-deferred 6% return than a tax-inefficient 3% return taxed annually, Joe, even though more tax will be payable on your death. The tax-efficient approach means you will likely have a larger estate value and a larger after-tax estate value.

Beneficiary designations

You can name a beneficiary for registered accounts, including RRSPs, RRIFs and TFSAs. If you are leaving these accounts to a spouse, you can name them as successor annuitant for your RRIF or successor holder for your TFSA. This allows them to take over the account directly.

You cannot name a beneficiary for a GIC in a non-registered account. An exception might be if you buy a guaranteed interest annuity (GIA). You can name a beneficiary of a GIA, because it’s considered an insurance product.

A beneficiary designation does not change the tax implications of dying. GIC or GIA interest is taxable annually, with no capital gains tax on death (because these investments do not appreciate in value).

At most, a beneficiary designation can avoid probate.

Probate versus income tax

Probate is the legal process of validating a will after death, so that the executor can distribute the estate to the beneficiaries. There may be probate fees, or other costs, to settle an estate. Probate fees vary by province and territory. For example, in Ontario, probate is called estate administration tax and is 1.5% of the estate’s value over $50,000. In Nova Scotia, probate fees are 1.695% over $100,000. In Alberta, probate is capped at $525 for estates worth over $250,000. In Quebec, there’s no fee for a notarized will (non-notarized wills have a $65 application fee).

Probate is not a significant consideration when it comes to estate planning for most people. Income tax is more impactful. But a key point is that avoiding probate does not avoid income tax.

What to do with your non-registered account

In summary, Joe, buying GICs will definitely avoid capital gains tax on your death. Buying GIAs may avoid probate. But avoiding stocks to avoid these costs may not achieve your goal to maximize your estate value.

Read more about estate planning:

• Inheritances can strain sibling relationships—how to make estate planning smoother

• How does a spouse’s death impact your TFSA contribution room?

• Should you take extra RRIF withdrawals to increase your estate?

• What type of financial advisor do you need?

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

Linkedin Twitter Facebook Website