Here’s what you and your trustee of your will need to know will happen to your RRSP when you die.
On the date of your death, your RRSP would have be considered redeemed – cashed out. There will be no tax withholding (NOT SAME as no tax payable) and the funds will be given to your beneficiaries on file according to the percentages designated. Therefore it is important that your beneficiaries are up-to-date. If there is no beneficiary designated then the money goes to your estate and distributed according to your will or regulations as it may apply.
As noted this does not mean that you don’t have tax payable issue. Your estate will be liable to pay what ever tax redeeming your whole RRSP all at once unless your have designated a spouse or disabled dependent as your beneficiary. Since this is considered a lump-sum redemption of your RRSP, your income for the year of your death has now just increased by the amount of your RRSP. If you have a small RRSP, then it may not have a great deal of impact, but if you have saved more then it may push you to higher tax brackets and your estate will have a higher tax bill.
Also note that it is your estate that will be responsible for the tax bill and not the beneficiaries. There is no tax withholding for disbursement on death and beneficiaries will receive full proceeds, leaving your estate to cover the tax payment. For example if you have $100,000 in your RSP and you have designated each of your child as 50% beneficiaries, they each will receive $50,000 and your estate is liable for for $25,000 in tax payable to CRA (assuming your average tax rate is at 25% and you have no other income). That money has to come from some where else in your estate.
This difference in tax treatment is the reason why I recommend that clients always designate their spouse/disabled dependent as the beneficiary, unless there are very good reason not to. And if you are not going to designate your spouse/disabled dependent, then designate your estate as the beneficiary so that it can pay the taxes out of the proceeds before distributing the funds to your heirs unless you have funds set aside for any tax liabilities.
If you have a spouse/disabled dependent and have designated them as the beneficiary, then they can perform a tax neutral roll over of the assets that was in your RRSP to their own RRSP/RDSP. They will have to report it as income (line 129) but they will receive an equal off-setting amount on line 232 leading to a tax neutral situation. You can also achieve the same result if no beneficiary is listed and the spouse and the estate representative can elect to roll over the RRSP to the surviving spouse’ s RSP. The process is longer but result will be the same. Of course if there are named beneficiary, this will not be an option and the funds will be paid to the beneficiary.
Nota Bene: From the time death and when RRSP are transfered into the right beneficiary’s account or redeemed, there may be a delay of several weeks or months or years. Income earned after the date of death is taxable in the hand of the beneficiary.
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