How is a RRIF taxed in the hands of a beneficiary?

A MoneySense reader writes:

If a registered retirement income fund (RRIF) is left to a named beneficiary, will the beneficiary have to pay income taxes on the RRIF amount?

I read in an earlier MoneySense article that all the taxes on the RRIF would be included on the deceased’s final income tax return. Does that mean the estate, and not the beneficiary, pays the income tax on the amount in the RRIF? 

FPAC responds:

The consequences of taxes and beneficiary designations on registered accounts like RRIFs can be confusing. Throw in questions about probate and they become even more so. Sometimes this confusion results in estate goals not being carried out as intended.

Let’s illustrate using some examples of Josie, her husband, Manwar, and her brother Noah. Josie has $100,000 in her RRIF and has recently passed away. 

Scenario 1

Josie lists her husband, Manwar, as the direct beneficiary on her RRIF contract. What happens upon Josie’s death? (For the purposes of this illustration, we did not distinguish between designating your spouse or common-law partner as a beneficiary versus a successor annuitant, although both can accomplish the same objective of a tax-free rollover of your RRIF. Naming a successor annuitant is simpler to administer, while designating a beneficiary involves more steps but can allow for enhanced planning on the deceased’s final return.)

Outcome

Upon death, the fair market value of Josie’s registered accounts, including her RRIF, is taxable as income on her final tax return, unless the spousal rollover provision applies. Because Josie and Manwar are married, the proceeds of Josie’s RRIF can be transferred to Manwar without any tax payable. And because Manwar was listed as the beneficiary on the RRIF contract, the RRIF funds do not form part of the estate for probate purposes.

Scenario 2

Josie has listed her estate as the beneficiary on her RRIF, and Manwar is the sole beneficiary of her estate. 

Outcome

Upon Josie’s death, her RRIF proceeds will pass through her will and are thus subject to any applicable probate fees (which vary by province and territory). However, her executor can still apply the spousal rollover provision, and in that case no income tax would be payable on the RRIF funds transferred to Manwar. 

Scenario 3

Josie is close with her brother Noah and wants to split her estate equally between her brother and her husband. Josie has listed Noah as the direct beneficiary on her $100,000 RRIF. Her only other asset is a high-interest savings account in her name, with a balance of $100,000. She intends for the funds in her savings account to go to her husband, Manwar. What happens when Josie dies? 

Outcome

Because Josie’s brother Noah is the direct beneficiary of the RRIF, the full amount of the RRIF proceeds will be transferred to him. As she has designated him as the direct beneficiary of her RRIF, the funds will not be subject to probate. However, because the spousal rollover provision does not apply, the RRIF will be fully taxable. 

While the Income Tax Act states that both the deceased’s estate and the RRIF recipient are “jointly and severally liable” for the income tax bill, in practice the Canada Revenue Agency only requires the beneficiary to pay the tax bill if the estate is insolvent. Therefore, in Josie’s case the tax would likely be paid from the high-interest savings account proceeds that are meant for Manwar, and he will receive less of Josie’s estate than Noah. 

Takeaways

• Spousal rollover provisions mean that income tax on registered accounts like RRIFs is not payable on a RRIF if the spouse is either a direct beneficiary or a beneficiary through the will. When the beneficiary spouse dies, whatever is left in the RRIF is taxable on their final tax return. 
• A direct, non-spouse beneficiary on a RRI—like Josie’s brother in Scenario 3—will receive the full amount of the RRIF proceeds. However, because the spousal rollover rules do not apply, the RRIF will be fully taxable when the original owner dies. Both the deceased’s estate and the RRIF recipient will be liable for the income tax due on the RRIF (although, unless the estate is insolvent, it will usually pay the tax).
• Assets passing outside of the will (as is the case with a named RRIF beneficiary) can potentially cause unintended inequitable distributions of your estate. 
• A direct beneficiary designation on a RRIF avoids probate fees. However, keep in mind that a misplaced emphasis on avoiding probate can be detrimental to achieving your true estate goals—and can even cause hard feelings among your intended beneficiaries. 

Proper estate planning for RRIF beneficiary designations is important for many reasons—including if you want your beneficiaries to be able to have dinner together after you are gone. To ensure you have an estate plan in place, speak to a qualified advisor to ensure the spirit of your wishes are properly reflected in the mechanics of your estate plan. 

This response was provided by FPAC Member Morgan Ulmer, a Certified Financial Planner who leads the Calgary office for the fee-for-service financial planning firm Caring for Clients. She has been involved in the financial services industry for 20 years.  

This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.

Qualified Advice is written by members of FPAC (Financial Planning Association of Canada) is a MoneySense content partner. The association’s goal is to set standards and principles that will allow financial planning to evolve into a knowledge-based profession that ultimately commands the credibility, public awareness and respect of other respected advisory professions, working closely with governments, regulators, financial planners, academia, vendors and the general public.

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• The MoneySense Find a Qualified Advisor Tool
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• How does a spousal RRSP withdrawal work?