At some point in your life you were probably asked to name a beneficiary on your RRSPs and TFSAs. You likely named a spouse or another family member, which might make sense in some cases – if you passed away unexpectedly, the assets in the account would transfer to the person you named.
“Beneficiary designation can be overly simplistic. People don’t seem to understand that when account holders name a person as a beneficiary, their assets are going to just that one person.”
However, for many individuals, having a beneficiary named on an account can cause problems. The main one? There is a risk that your estate may not be divided as you anticipated, says Christine Van Cauwenberghe, Vice-President of Tax and Estate planning at IG Wealth Management.
“Beneficiary designation can be overly simplistic,” she says. “People don’t seem to understand that when account holders name a person as a beneficiary, their assets are going to just that one person. They believe those assets will be divided according to their will.”
In many cases, you should designate your estate as the beneficiary. Here’s why.
Fairness in big families
Individuals with more than one child might believe that it is a good idea to name them all as beneficiaries on their registered accounts. You might think that if a child predeceases you, their kids – your grandkids – would receive their share. That’s not so. “Even when you designate all the kids as beneficiaries, if one of them predeceases you, then their kids don’t get their portion,” says Van Cauwenberghe.
Instead, that money will be redistributed to the living heirs only, leaving one branch of the family tree with nothing. That could cause resentment if there is significant wealth in your registered accounts, she says.
Leaving money to young children
Leaving your assets to minor children might not seem like a big deal – they’ll probably be grown by the time you pass away. Plus, you may have stated in your will that your heirs should get their money over a period of time instead of right away.
Since funds paid out by way of direct beneficiary designation are not governed by the will, if you do pass away early, young children may receive a lump sum of money they’re not ready to handle. “People assume if their will states that money is to be given to minors that it will be held in trust until age 30,” she says. “The problem is that funds paid out by way of direct beneficiary designation aren’t subject to the terms of your will.
“If you’ve designated a 4-year-old as the beneficiary, they’ll be entitled to it upon reaching the age of majority, as opposed to the age designated in the will, which can be a problem. Since the minor won’t be capable of managing the funds before that time, they might be paid over to provincial authorities to manage until the child reaches the age of majority.”
Some families have members who have problems managing money. In that case, you likely wouldn’t want all your assets going to that person. But maybe you didn’t know about their spendthrift ways and added them as a beneficiary? That’s precisely why you should think twice about naming a specific person on your RRSP and TFSA.
“If the beneficiary has creditor issues, then you wouldn’t want to designate them as direct beneficiary,” says Van Cauwenberghe. A better solution may be to designate the estate as the beneficiary of the plan, and then leave the funds to the beneficiary through a trust. “That may help to protect the money from the beneficiary’s creditors,” she says.
With so many second marriages these days, many people designate their new spouse as a beneficiary by default. It may seem like the right thing to do, but it’s tricky – if you pass away, it’s the new partner who will receive the funds, and not your children from your first marriage.
“You likely don’t want all of your assets to just go to your new spouse,” says Van Cauwenberghe. “If they pass away, those assets could go to their family, leaving nothing for your kids from your previous relationship.”
When someone passes away, any money inside an RRSP or a registered retirement income fund (RRIF) will get taxed. (TFSAs are generally not taxable.) Usually, it’s the estate that’s responsible for the tax hit, not the beneficiary who receives the funds, says Van Cauwenberghe.
While there are some circumstances where that tax liability can be transferred to the beneficiary, that’s not possible in every case. “That’s when things don’t go according to plan, because money has gone in one direction and the tax burden has gone in another,” she says. “That can make things doubly unfair.”
Appoint the estate
The one way to avoid all these hassles is to make your estate the beneficiary. While you’re filling out the paperwork on your RRSP or TFSA, put down the word “estate” in the beneficiary section.
You’ll then have to update your will – and keep it updated – so any assets that get transferred to the estate end up in the right hands. If you don’t have a will, your family could end up in court, says Van Cauwenberghe.
While most people designate a specific beneficiary, this is not always the recommended approach for making sure your savings go where you want them to go after you’re gone. “People think they should always designate a beneficiary, but our advice is that more often than not you need to designate the estate,” says Van Cauwenberghe. “People don’t pay enough attention to it and that mindset needs to change.”