RRSP's and RRIF's ("Retirement Plans") are used as retirement savings vehicles because of their built-in tax deferral mechanisms. Contributions to an RRSP are made out of income that is not taxed (since a deduction is allowed for the contribution), and investments in an RRSP or RRIF grow tax-free until the funds are withdrawn.
However, when a taxpayer dies, there can be a significant tax bill. If no special steps are taken, the deferral stops and the taxpayer is deemed to have received, immediately before death, a benefit from the Retirement Plan equal to the fair market value of all property of the Retirement Plan (a deduction Is allowed for any loss in value, including selling commissions, down to the amount actually received out of the plan, if the plan is wound up by December 31 of the year following death.)
This tax bill can usually be deferred until the death of the taxpayer's spouse or common-law partner if the spouse or common-law partner is designated as the beneficiary of the Retirement Plan. Where the spouse or common-law partner is the designated beneficiary of the Retirement Plan and the property is directly transferred to a Retirement Plan of the spouse or common-law partner, a rollover can be used to defer tax until the spouse or common-law partner withdraws the money or dies. Naming a direct beneficiary will normally also avoid provincial probate fees or estate administration taxes, since the funds do not go through the deceased’s estate.
If the spouse or common-law partner is not named as the direct beneficiary, the tax on the taxpayer’s death can still be avoided if the surviving spouse or common-law partner transfers the funds into their Retirement Plan within 60 days after the year of the taxpayer's death.
Where there is a child with special needs there are some methods for deferring the tax on the taxpayer’s death even if the recipient is not the spouse or common-law partner. If the deceased had a child or grandchild who has a severe disability and was financially dependent on the deceased, at the time of death, by reason of mental or physical infirmity, proceeds from the deceased’s Retirement Plans can be rolled into a Registered Disability Savings Plan (RDSP) for such a child or grandchild. The amount that can be rolled into the RDSP is limited to the beneficiary's available RDSP contribution room (the lifetime limit is $200,000) and the government will not pay the Canada Disability Savings Grant on these transfers.
Under proposed legislation, Retirement Plans can also be rolled into a "lifetime benefit trust" (LBT) (commonly known as a Henson trust) for a child/grandchild of the deceased who was dependent on the deceased for support by reason of mental infirmity. Dependence based on physical infirmity does not qualify as a basis for this rollover. The rollover to a LBT is also available for a mentally infirm spouse or common-law partner.
Rollovers of Retirement Plan funds are not only available to spouses or common-law partners. In special needs situations there may also be opportunities to defer tax otherwise payable on death on a Retirement Plan annuitant. Your TSG representative would be happy to discuss these options with you.
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