If beneficiary designations conflict with your will, your will may not be done
By Olev Edur
When it comes to planning your estate, beneficiary designations can be quite useful, and they’re available for various financial products, including life insurance policies, RRSPs, RRIFs, and TFSAs. But you need to take care with such designations—if applied without due diligence, your estate plan may suffer grievous and irreparable harm.
Most retirees understand the advantages of these designations—assets can pass immediately to beneficiaries, bypassing the costs and delays of the probate process. But in the haste to reap these benefits, the potential hazards—as well as better possible alternatives—may often be overlooked.
“For starters, you must ensure that the designations you make for any of these plans don’t conflict with any similar provisions stipulated in your will,” says Nicco Bautista, the director of estate planning with BMO Private Wealth in Vancouver. “If they aren’t coordinated with your will and overall estate plan, the results can be disastrous.”
Those negative results can include the distribution of assets to unintended parties. “In general, when it comes to conflicts between designations in your will and in plans such as RRSPs, the latest designation rules the day,” Bautista notes, adding that this may not be at all what you intended when creating your will.
“Where there’s confusion between designations made by your will and in registered plan documents, delays and possibly court action can result,” says Georgia Swan, a tax and estate planner at TD Wealth Advisory Services in Barrie, ON. “Generally, if you’ve made a beneficiary designation in your registered documents and you’re satisfied with it, you need not make mention of the designation or the asset itself in your will in order to avoid confusion.”
In addition, testators should understand that while the rules are generally similar, the details can vary between different types of plans. “You have to look at all these plans separately,” advises Susanne Greisbach, a senior advisor at National Bank in Ottawa and a trust officer with National Bank Trust. “Beneficiary designations in registered plans, TFSAs, and life insurance all have different tax and probate implications, so you have to look at them separately.”
Similarly, the forms used by different institutions to make these designations can also vary. “You have to make sure you know what you are doing with each institution’s forms and what happens, for example, if you designate more than one beneficiary or you appoint a contingent beneficiary,” Greisbach says.
Furthermore, while these documents may formalize your wishes, you can never be sure whether something may fall through the cracks. “If you’re changing any designations in these plans, for example, make sure all par- ties involved—financial institutions, your lawyer, financial advisor, insurance providers—all know what you’re doing,” Bautista says. “You need to make sure everyone is on the same page. By default, most of the necessary forms state this, but you should still contact everyone and let them know your current intentions.”
Planning for Life’s Changes
A great many problems can arise from the fact that many aspects of our lives change over time, which is why beneficiary designations need to be reviewed regularly.
“One of the main things that scares us as advisors is when someone has gone through a divorce,” Bautista says.
“Divorce doesn’t cancel beneficiary designations, so if you’ve named a now- former spouse as beneficiary and leave this unchanged, the money will pass to him or her, which is probably not what you want. Whenever you change any of your estate-planning pieces, you need to review everything.”
“You should update beneficiaries whenever your life or your wishes change,” advises Jennifer Poon, a director of advanced planning at Scotia Wealth Management in Toronto. “For example, separation or divorce, birth or adoption of children or grandchildren, marriage or remarriage, the death of a beneficiary…. And it’s always a good idea to name contingent beneficiaries should your primary beneficiaries die or become unable to receive the gift. If you don’t name an alternate, the default is the estate, which can result in tax and probate implications.”
“There are as many examples of problems that may arise from failing to keep your estate planning up to date as there are estates,” Swan says. “For
example, if you’ve made a beneficiary designation in your will with respect to your RRSP but you turn 71 and convert your RRSP to an RRIF, that beneficiary designation will no longer be valid.
“Another consequence of not updating your beneficiary designations can occur as a result of incapacity,” Swan adds. “If you become incapable, a Power of Attorney for Property document cannot change the beneficiaries that you have named in your registered accounts. Contingent or alternate beneficiaries are always a good idea.”
Location, Location, Location
Different problems may arise as a result of location, whether yours or the beneficiaries’. Although the rules are similar in most provinces (estate planning falls under provincial purview), there are some notable differences.
“In Quebec, for example, you can’t designate beneficiaries in registered plans or TFSAs,” Bautista says. “These plans must go into the estate, and designations must be made in the will.”
Probate fees also vary by province. For example, in British Columbia, Ontario, and Nova Scotia, these fees can amount to thousands of dollars, whereas in other provinces, they may be just a few hundred dollars; in Quebec, the fee for a notarial will is just $65. As such, money-saving strategies can vary considerably depending on where you live.
“That’s important if people move between provinces—especially between Quebec and the common-law provinces—or if you have your assets in one jurisdiction and your financial advisor in another,” Greisbach says. “There’s one set of rules in Quebec, for example, and another in Ontario, where the probate fees are much higher, but this might not be top of mind for an advisor in Quebec. You need to double-check your planning and your designations if you’re moving from one province to another.”
Swan points out that it’s not just varying estate laws you need to consider: “Estates are affected by almost every area of law, including family, bankrupt- cy, real estate, and tax law. In Ontario, for example, common-law spouses don’t have the same rights to the property of their spouses as married spouses, while Alberta and British Columbia provide full property rights to common-law spouses. This may have a significant effect on your planning, so it’s important that you receive tax and legal advice specific to your province of residence. And if you move from one province to another, you must not assume that the same rules will apply.”
Further problems can arise if your beneficiary or beneficiaries live abroad. “Unintended tax consequences may result to the beneficiary and increased administration fees may result to the estate if the beneficiaries aren’t residents of Canada,” Swan notes.
The Tax Problem With RRSPs and RRIFs
One common estate fiasco stems from the fact that the proceeds of all registered plans (RRSPs, RRIFs, etc.) must be included as income on your final tax return, and that this tax bill must be paid by your estate. The only exception is where the plan(s) can be rolled into the registered plan of a spouse, common-law partner, or even a disabled dependant, in which cases the tax bill can be deferred.
The problem arises when a beneficiary other than a partner or qualifying dependant is designated; the plan beneficiary receives the plan proceeds tax-free, but then the estate—including other beneficiaries—must pay the tax. In a worst-case scenario, there may be nothing left afterwards.
“Taxes on RRSPs or RRIFs can be a huge problem when it comes to equal- ization among your heirs,” Bautista says. “Any registered account will be taxed as income in the year of death; that tax must be paid by the estate, meaning that the beneficiaries in your will pay it. If the will beneficiaries aren’t the same as the RRSP beneficiaries, that can create a big imbalance.”
“If you designate your spouse as successor annuitant of your RRSP or RRIF, you can take advantage of the tax-free rollover—if not, there’s an income-tax liability,” Greisbach says. “That tax must be paid by the estate. So if, for example, you have no spouse and leave money to your two children but designate only one child as RRSP beneficiary, that child will get the entire amount tax-free, but the estate—meaning the other child—will have to pay the taxes.
“There are ways to compensate for this imbalance,” Greisbach adds. “In provinces where you’re not worried about probate fees, you can have the estate as beneficiary. The estate pays the tax and whatever is left is split between the kids according to your will. In provinces with high probate fees, some financial institutions may allow you to designate more than one RRSP or RRIF beneficiary. But you need to check with the particular institution to ensure this is the case.”
Bautista adds: “When the beneficiaries in the will and in the registered plan are the same, it’s okay to designate a direct beneficiary rather than the estate. The people who get the money also pay the taxes and fees, so it balances out. You haven’t changed who gets what, but you’ve saved some probate fees.”
Making Use of the Spousal Rollover
As for the spousal successor annuitant option, the consensus is that it’s preferable to an ordinary beneficiary designation.
“It’s generally desirable for a spouse or common-law partner because it’s simpler; there are tax advantages and you get more flexibility,” Bautista says. “With a RRIF, for example, the minimum payments may be based on the age of the older partner, but a younger spouse can change this so they correspond to his or her age to reduce the size of the payments, if desired.”
Swan notes that even if a surviving spouse isn’t named as the designated beneficiary but the deceased leaves a will stating that the entire estate is to be left to the spouse, “the executor of the estate and the spouse may make a joint election under the Income Tax Act to have the tax deferral operate as if the beneficiary designation had been made.”
TFSA designations, by comparison to registered plans, are far less problematic because there’s no final tax bill to upset one’s estate-planning apple cart. Upon death, the plan simply ends and a direct beneficiary designation serves to avoid probate (except in Quebec). As with registered plans, however, any further earnings from those monies will be taxable in the beneficiaries’ hands.
In addition, as with registered plans, there’s a “successor holder” designation available for spouses, in which case probate is avoided and the plan continues in the spouse’s name without affecting his or her own TFSA contribution room. “You can name your spouse as the successor holder so that the amount in the TFSA stays sheltered and is simply trans- ferred into the surviving spouse’s name,” Poon says.
Special Life-Insurance Features
Life-insurance proceeds are for the most part tax-free for beneficiaries (although certain types of policies may have accumulated investment earnings that are taxable), and the death benefit is fixed. This certainty can be particularly helpful when it comes to the equalization of multiple beneficiaries’ shares of an estate. There are cases, however, in which designating the estate rather than individual beneficiaries can be advantageous.
“When it comes to life-insurance beneficiary designations, the first thing to consider is intent,” Bautista says. “Why did you get the policy in the first place? For some people, life insurance is intended to pay off the taxes and other debts of the estate. For example, the estate may include some accrued but untaxed capital gains in non-registered accounts, or there may be those taxes on registered-plan balances. If so, the estate should be named as beneficiary to avoid imbalances.
“Those who own a company and have taken out a corporate policy intended to pay off the debts and taxes of the business need to ensure that person designated as beneficiary is the person responsible for paying those bills,” Bautista says.
Swan notes that insurance policies can accommodate multiple beneficiaries: your spouse, children, dependants, another family member, a friend, or a charity. “If you name more than one beneficiary, the insurance company will divide the death benefit between them,” she says, adding that you can also stipulate percentages for each. But as with registered plans, you need to consider alternates in case any primary beneficiaries should become unavailable.
“One thing that is particular to insurance policies is that an insurance policy can be a jointly held asset,” Swan says. “Take, for example, a joint last-to-die policy, which is owned jointly by two spouses. If one of the beneficiaries the becomes incompetent, the designated beneficiaries of the insurance policy can no longer be changed.”
Added Considerations for Minors
When it comes to designating a minor as a beneficiary of any plan or insurance policy, you need to undertake a further layer of planning. “If you’re naming minors as beneficiaries, there’s a need for additional planning,” Bautista says. “Minors can’t receive the money until they come of age, and the age can vary from province to province. Or they may not be mature enough to handle the money responsibly.”
“Because they can’t receive the funds until they’re of age, to maintain control of those assets, you may have to put them into a trust,” Greisbach says. “You may be able to use a life insurance trust, which is an extended beneficiary designation where you name trustees to control the money on behalf of the minor. Most institutional beneficiary forms don’t allow for this arrangement, though, so you may have to orchestrate it with an estate-planning lawyer.
“If you haven’t provided for a minor child or spouse to whom you owe support through your will, and if you then divert funds in a TFSA or RRSP/ RRIF to other persons through a beneficiary designation, those funds could be clawed back into the estate to satisfy a dependant’s support relief claim under family law legislation,” Greisbach says.