Not Just a Minor Issue
Reconsidering minors as direct beneficiaries for RRSPs
by Doug Carroll, April 2010
When are children ready to be fully in control of their property and finances? For most parents, the answer would be to employ a gradual process beginning at an early age, extending out to and beyond age of majority. So, if tragedy struck and the parents were no longer there, how well served would those parental desires be by having named their minor children as direct RRSP beneficiaries?
Provincial laws allow for the naming of beneficiaries on RRSPs, generally enabling the bypass of the deceased's estate for both probate and estate creditor purposes. Concurrently, the Income Tax Act (Canada) causes the RRSP value to be included in terminal year income, with deferral in limited circumstances. For present purposes, where a financially dependent minor child is named, these rules require that an annuity be purchased with payments continuing to age 18.
It is this rigid payment schedule that raises serious concerns whether it is in the best interests of parents to enable the child to use the rollover election or, for that matter, if it is in the best interests of the child to exercise that election.
Also bear in mind that, as opposed to life insurance where a trustee can be named to receive proceeds, it is not possible to hold an RRSP in trust. Accordingly, the parent's death is arguably a divestiture of any continuing legal influence over the RRSP proceeds where a minor is named as direct beneficiary.
OPTIONS FOR REGISTERED PLANS
There are a few ways that RRSP proceeds may be transferred at death:
- Direct designation on the RRSP. This is the most common procedure, particularly between spouses.
- Direct designation using the Will or other instrument. This may be necessary if more complex instructions are desired that the plan administrator cannot accommodate.
- Naming/allowing estate as beneficiary. The executor may jointly elect rollover to a qualified beneficiary or distribute after-tax proceeds as a legacy or estate residue.
- Direct proceeds to a separate RRSP trust. Canada Revenue Agency (CRA) has commented that after-tax proceeds may go to a testamentary trust outside of an estate.
ESTATE PLANNING FACTORS
In deciding how to proceed, there are some key tax and estate planning considerations that parents should keep in mind.
- Preserving tax sheltering. Significant tax savings may result from initial RRSP rollover to a beneficiary. But consider too that the terminal return is entitled to low bracket rates (particularly for deaths early in the year), tax credits and liberal loss carry-forward rules.
- Annuity income at low bracket rates. While registered annuity income is taxable to the minor at presumed low bracket rates, a testamentary trust is an effective tool for ongoing strategic management of graduated bracket rates of both the beneficiary and the trust.
- Control post-transfer. Where a minor is the direct RRSP beneficiary, the proceeds are systematically released to the child until fully distributed by age 18.
- Avoiding probate. While any probate tax/fee may be avoided, the naming of a direct beneficiary also entails that no testamentary trusts may be established using those funds.
- Guardianship. A guardian has the legal duty to provide the child with the necessities of life. Absent permission of the Public Trustee's office or court intervention, the child's own assets, including annuity income, cannot be used for this purpose.
- Custodianship. A custodian may legally control a minor's assets. However, the custodian is a fiduciary with very high priority for safety of capital. If more diversified investments are desired, it may require approval and monitoring by the Public Trustee.
- Migration to non-registered assets. For investment of after-tax annuity income, it is likely that financial institutions would limit it to low-risk interest options, as minors cannot legally contract. Similarly, the minor's custodian would have to be very conservative.
- The use of trusts generally. A deceased parent can draft trust terms to allow access during minority, delay distribution beyond majority, pay expenses otherwise falling upon a guardian and give wide investment discretion. Compared to custodian and guardian roles, a trustee is also a fiduciary, but far less fettered by government agencies or courts.
- Testamentary trust taxation. Testamentary trusts have many useful tax characteristics, including initial year-end selection, graduated tax brackets (including coordination with beneficiary brackets) and ability to roll-out assets at adjusted cost base.
OBTAINING AN ANNUITY
As a final note, here are some issues to consider with respect to purchasing the annuity.
- Release from deceased's RRSP. The plan administrator may await the appointment of a custodian or pay the proceeds into court, given that a minor cannot sign a binding release.
- Proof of claim. The plan administrator may request a notarial copy of the Will, or possibly a probated Will, in order to confirm there is no superseding designation.
- Available issuers. A registered annuity is generally obtained from an insurance company licensed for annuities, this type being a term certain annuity until the minor reaches 18.
- Short-term annuities. For beneficiaries aged 17 (and possibly aged 16 or even 15 if there are significant delays), it may be a challenge finding an issuer to provide a term certain annuity spanning less than a year.
- Rate of return. The pricing of a term certain annuity is based on the prevailing interest environment at time of purchase.
DOUG CARROLL, JD, LLM (Tax), CFP, TEP, is vicepresident, tax & estate planning, at Invesco Trimark Investments.
This article was published in the April 2010 issue of FORUM magazine. Posted with permission from the Financial Advisors Association of Canada (Advocis).
These resources are provided for reference only and do not necessarily represent the opinions of Guilfoyle Financial Inc. Please consult your own tax and legal advisors.