The Good, The Bad, And The Ugly: The Consequences Of RRSPs On Your Estate, Beneficiaries

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On March 14, 1957, the Honourable Walter Harris, Minister of Finance under the Liberal government of Louis St. Laurent, delivered a landmark budget speech to Canada's House of Commons..
Canada Family and Matrimonial
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On March 14, 1957, the Honourable Walter Harris, Minister of Finance under the Liberal government of Louis St. Laurent, delivered a landmark budget speech to Canada's House of Commons. Despite John Diefenbaker's rise to power on June 10, 1957, mere months later, the groundwork was laid for the implementation of the registered retirement savings plan (RRSP) in Canada.

The stated objective of RRSPs was related "to tax postponement on income set aside for retirement". This objective has remained the same in the 67 years since. The more things stay the same, however, the more they change.

The annual contribution limit in 1957 was the lesser of $2,500 and 10% of the annuitant's earned income in the year prior. That limit for 2024 has risen to the lesser of $31,560 and 18% of the annuitant's earned income in the year prior. That change, in fact, outstrips the rate of inflation.

With tax-deductible contributions and tax-deferred income generation within the plan, not to mention the automatic carry forward of unused contribution room from years prior, one might wonder what are the downsides of RRSPs?

A few points to consider:

  1. If you have a company pension plan, you are subject to an annual pension adjustment which reduces your RRSP contribution limit;
  2. RRSPs are investment vehicles available to taxpayers under the age of 71. The later an annuitant starts to contribute to an RRSP, the lesser the benefits he or she might realize; and,
  3. Contributions to an RRSP that exceed your available limit by more than $2,000 are penalized at a rate of 1% monthly until the excess is withdrawn or the contribution limit grows to allow room for the excess amount.

Moreover, and perhaps more subtly, you can designate a beneficiary to receive the proceeds of your RRSP at your death, allowing a direct, creditor-protected transfer of the asset without the need for probate. As advantageous as this may seem, however, it should be considered mindfully as, without proper planning, the tax burden of that transfer may rest with your estate.

Not to mention the fact that only a certain narrow class of beneficiaries, including married or common-law spouses, financially dependent minor children or grandchildren, or financially dependent and infirm adult children or grandchildren, are eligible to receive the proceeds of an RRSP on a tax-deferred rollover basis. Nieces and nephews, brothers and sisters, parents and even trusts are each absent from this list.

In 1957, not long after Mr. Harris' budget speech, Fraser Deacon, CLU, delivered a special lecture to the Law Society of Upper Canada in the area of estate planning, entitled "The Use of Life Insurance in Estate Planning". In concluding his lecture, Mr. Deacon cautioned that "[b]efore jumping to the conclusion that everyone will run out and buy one of these annuities, it is important to recognize two road blocks which will certainly slow down the rush:

  1. With "in-payments" free from tax the "out-payments" under a registered retirement annuity will of course be fully taxable.
  2. These annuities will not be assignable and a person issuing them may not redeem the contract for cash or make any loan against them.

This latter restriction removes possibly the most widely used of all provisions in regular life insurance contracts."

To this day, we can accept that the tax benefits enjoyed on contributing to an RRSP are not tax elimination, but tax deferral. The general idea being that upon retirement, the annuitant will be taxed on his or her withdrawals from the RRSP at a lower marginal rate than when the annuitant was working. Full tax on "out-payments", therefore, is perhaps not a significant roadblock to the average taxpayer. And of course, tax deferred is tax saved.

The second point, however, is interesting and features in the case law. Turning to the Ontario Court of Appeal's decision in Whaling, Re, 1998 CanLII 5931, a borrower pledged the proceeds of his RRSPs to maintain his ability to borrow from his financial institution. The borrower declared bankruptcy, the financial institution moved to "set off the amounts in those accounts against debts owed", and the Trustee in Bankruptcy went on to allege that the arrangement ran afoul of s. 146(2)(c.3) of the Income Tax Act.

However, as Doherty JA clarified at paragraph 26 of Whaling: "I do not think s. 146(2)(c.3) forbids the beneficiary from using his RRSP as security if he or she chooses to do so. Rather, it dictates that if the beneficiary chooses to pledge the funds, in the plan as security, the plan ceases to be a registered retirement savings plan." As a result, the pledged RRSPs were found to be deregistered, and the financial institution was correspondingly found to have a right of offset.

The year 1957 ushered in heady times. To again quote the words of Mr. Deacon: "the new legislation represents a big step forward for the self-employed and for many employees." And as Mr. Harris said: the "provision being made by Canadians towards freedom from financial worry at a time when their earning power has lessened [...] makes good sense." Indeed, the RRSP has withstood the test of time and remains an important estate and retirement planning tool to this day.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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