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Registered Retirement Plans with named beneficiaries: Unintended Consequences

Investments, Personal Finance

Posted by Peter Wouters

Jun 6, 2016 11:10:18 AM

Directeur, Planification fiscale et successorale et planification de la retraite, Gestion de patrimoine
Placements Empire Vie

Let’s say you’re single, divorced or widowed. You have saved up some money for retirement. Perhaps you are already retired and are taking out an income from your registered plan. You may not get to spend all of your savings during your lifetime. Where does the balance go?

One of the strategies you can use for your Registered Retirement Savings Plan or Registered Retirement Income Fund is to name a beneficiary. The balance of the plan goes directly to that person after you die. It passes outside of your estate. That means it doesn’t form part of the assets in your will or have to go through probate. All of it goes to the person you choose to receive that money. That’s right; the beneficiary normally doesn’t even have to pay the income tax on all that tax deferred money.

Income tax still has to be paid. That bill goes to your estate. Your executor or estate administrator must pay the income tax that is owed on the disposition of your registered retirement plan because that amount is reported on your last income tax return. Cash, investments or some other asset in your estate will be used to pay the income tax bill.

Okay so far?

What about the beneficiaries of the estate? They in fact shoulder the income tax liability while the beneficiary of the registered retirement plan gets all of the money. Those other beneficiaries may not think that’s fair. You may not have intended that to happen. The person who got the registered retirement plan money may also be a beneficiary under the will. That means they stand to get a lot more of the estate. Was that your intention?

This scenario is fairly common. Unhappy beneficiaries, who may be brothers and sisters of the beneficiary named under the registered retirement plan, may well dispute that outcome. They may even go to court to get satisfaction. The Morrison v. Morrison (Re Morrison) case settled in Alberta in December, 2015 dealt with just this kind of scenario.

John Morrison (dad) drew up a will dividing his estate amongst his four adult children. Each of his grandchildren was to receive a small, precise amount of money.

One son, Douglas, was subsequently named the sole beneficiary of John’s Registered Retirement Income Fund. He also cared for his dad and was one of the executors.

When John died, Douglas found out he was to receive the proceeds of John’s registered retirement income fund and was entitled to ¼ of the estate. The estate was responsible for the income tax on the registered retirement income fund, reducing each child’s share of the balance of the estate. There wasn’t enough money to provide for the amount to be gifted to each grandchild.

The judge ruled that on the balance of probabilities, John had intended to gift the registered retirement income fund to his son Douglas. The court ruled that Douglas didn’t have to share the proceeds from the registered retirement income fund because it was his outright. The judge did order Douglas to pay the income tax on those funds. This unusual decision relied on a piece of Alberta legislation. The judge admitted his approach was extraordinary in claiming that Douglas was unjustly enriched and must reimburse the estate for the tax it paid on his behalf. The judge inferred that dad (John) either didn’t know or was mistaken about how the income tax liability would be borne.

What are some lessons and considerations? Wait for my next blog on this subject.