Is it possible to avoid tax as a RRIF beneficiary? Find out if timing could be an issue, as well as rules around withdrawals, too.
As the beneficiary of a RRIF, can I transfer the funds to my RRSP or RRIF to avoid taxes?
I am 71 and have to transfer my funds to a RRIF by December 31.
Sorry for your loss, Gay. I am happy to try to provide some input here.
When a taxpayer dies, they are deemed to have disposed of their assets on their date of death. This includes a registered retirement income fund (RRIF). The fair market value of their RRIF is generally reported on a T4RIF slip and added to their income on their final tax return for the year of death.
Tax payable on a RRIF can be significant. Depending on the province or territory and the other sources of income for the deceased, more than 50% tax may ultimately be payable on the RRIF value.
A registered retirement savings plan (RRSP) is also taxable on death and reported on a T4RSP slip. So, a registered retirement account, whether before or after conversion, is subject to tax on death of the account holder, Gay.
A few rules around RRIF and RRSP withdrawals
RRSP withdrawals are generally subject to tax withholding. RRIF withdrawals that exceed the year’s minimum withdrawal are subject to withholding tax as well. However, upon death, no withholding tax applies to RRSP or RRIF accounts. This is the case whether the estate or a specific individual is the beneficiary of the account.
Even though the tax payable on the RRSP and/or RRIF income is the responsibility of the estate of the deceased, a 2016 Tax Court case (O’Callaghan v. The Queen, 2016 TCC 169) found that “the recipient of a tax-free amount out of or under a RRSP is jointly and severally liable with the deceased annuitant for the deceased’s additional tax payable that arose because the amount was included in the deceased’s income.”
Essentially, a beneficiary may be on the hook for the tax payable if there is not enough money left in the estate. This could apply if a RRSP or RRIF is the primary or sole asset of an estate. However, it is an important consideration if a RRSP or RRIF beneficiary is different from the beneficiary of the remainder of the estate when figuring out who gets what from an estate.
Does a beneficiary pay tax? Can that tax be deferred?
If a RRSP or RRIF beneficiary is the spouse or common-law partner of the deceased, or if they are the beneficiary of the estate of the deceased, it may be possible to defer tax, Gay. This tax deferral can apply if the proceeds are transferred to their own RRSP or RRIF by December 31 of the year following the death of the account holder.
In this case, a T4RSP or T4RIF slip will instead be issued to the spouse beneficiary who would claim the income and could also claim an offsetting deduction on their tax return to avoid taxation.
Future withdrawals would be taxable to the spouse beneficiary over time. It does not matter if either the transferring or receiving account is a RRSP or a RRIF. It also does not matter if the beneficiary spouse does not have a RRSP or RRIF, as they can open one to receive the transfer.
Beyond a spousal beneficiary, a financially dependent minor child or grandchild, or a financially dependent mentally or physically infirm child or grandchild may also qualify for a tax deferred transfer.
The nearing deadline to convert RRSP to RRIF
In your case, Gay, if you turned 71 this year, you are correct that December 31 is an important date. You must convert your RRSP to a RRIF by that deadline, or purchase an annuity from a life insurance company, as your RRSP cannot exist thereafter.
Regardless, if you are a RRIF beneficiary and the spouse of the deceased, you can transfer the amount into your RRSP or RRIF, so the timing of converting your own account will not matter for purposes of the transfer.
If you are not the spouse of the deceased, and you are not their financially dependent or mentally or physically infirm child or grandchild, there is no tax relief. Again, the tax would be paid by the executors of the deceased out of their estate and the income and tax would not be on your tax return.
One exception could be for income earned in the account after the death of the account holder, for which you would receive a T4RSP or T4RIF to report the income and pay the associated tax.
Inheriting an RRSP in Canada
If you have RRSP room of your own, Gay, you may be able to use the inheritance to contribute to your RRSP before converting it to a RRIF. This would likely reduce your own tax payable but may or may not be advisable. If your income is relatively low, a RRSP contribution, even if you have the funds, may result in little tax savings today. If your income could be higher in future years as you begin RRIF withdrawals, contributing to your RRSP this year could be disadvantageous with a higher tax rate on withdrawal.
Hopefully this helps clarify your options with the RRIF proceeds, Gay. Good luck and if you do not use an accountant to prepare your tax return, this could be a good year to seek advice.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
If you have a question for Jason, please send it to [email protected]