Hello everyone, and welcome to the Retiring Canada podcast. In today’s episode, we’re going to discuss the dos and don’ts of naming beneficiaries on your retirement accounts and insurance policies. It might not sound thrilling, but you'd be surprised how often mistakes happen and how damaging they can be, both emotionally and financially, for your family when you're gone.
Specifically, we will cover:
- Three scenarios where naming a direct beneficiary makes sense
- The impact of probate planning on your estate and family
- Scenarios where naming a direct beneficiary is strongly advised against
- Considerations for dependents with disabilities
- Factors to consider if you have a blended family
- Potential tax issues that can arise upon your passing
- Action items for you to consider
Let's start with scenarios where naming a direct beneficiary on your retirement accounts makes sense. When I say retirement accounts, I mean your RRSP, RRIF, defined contribution pensions, etc.
The first scenario is for individuals in their first marriage or relationship. If the goal is to leave the entire estate to the surviving spouse, naming them as the direct beneficiary can make sense. However, if you have children from a previous relationship or a spouse or child with a disability, you will want to rethink this strategy. More on those points later.
The second scenario is where an individual wants to leave their entire estate to one beneficiary, whether it's an only child or a charity. In this case, you should still consider the beneficiary’s financial maturity, exposure to creditors, and whether or not they have a disability.
The last scenario is when there are concerns that the estate may be bankrupt or insolvent. If you wish to have assets pass outside of your estate to avoid creditors, speak to your estate lawyer or notary about structuring your assets to better achieve your estate planning objectives.
Outside of these scenarios, beneficiary planning can become murky. Often, families try to avoid having their assets go through the estate to save on probate fees. Probate fees vary from province to province; in Saskatchewan, probate costs $7 per $1,000 of the estate. On a million-dollar estate, that’s $7,000 in probate fees.
While that may seem significant, probate planning can sometimes disinherit intended beneficiaries, cause unequal inheritances, and deepen family tensions. You'll soon realize that "probate planning" can have serious negative consequences.
Let’s now shift gears to discuss the "don'ts" when naming direct beneficiaries.
First and foremost is naming a minor beneficiary or young adult. If you name a minor child as a beneficiary of a retirement account or insurance policy, the money must be held in trust until they reach the age of majority.
Often, the surviving parent does not have authority to manage the minor's assets unless they obtain a court order of financial guardianship. Without this, the funds may have to be managed by provincial authorities, which is probably not what you expected.
Even for young adults, many might not be competent enough to manage a large sum of money. It's often best to name your estate as the beneficiary and outline in your will that the funds be held in trust for the minor or young adult until they are more mature.
A second scenario where naming a direct beneficiary is not recommended is when naming a disabled beneficiary. A person with a disability who inherits property directly may be subject to a claw-back of provincial social assistance. For example, naming a disabled child as a direct beneficiary on RRSP accounts might disqualify them from income grants or other benefits.
Additionally, if the disabled person is mentally impaired, a public trustee or government agency may need to manage the funds. Even if they are only slightly impaired, they might still be vulnerable to financial predators.
A common solution is to pay accounts and policies to the estate and create a discretionary trust (such as a Henson Trust) for the disabled beneficiary, which can avoid benefit claw-backs and prevent financial exploitation.
The next scenario where naming direct beneficiaries is not recommended involves blended families. Proper estate structuring is crucial here. If all assets are left to the surviving spouse, there is nothing forcing that spouse to maintain your wishes to provide an inheritance to children from a previous marriage. Courts do not recognize children from a spouse's previous marriage in inheritance cases if the second spouse dies without a will.
A common approach is to pass a portion of the assets to naturally born children at the first spouse's passing while leaving the remainder to the surviving spouse. This is a simplified example, so consult with legal counsel before implementing any strategy.
For more on planning for blended families, check out Episode Two of the podcast.
The last scenario I'll discuss today is the designation of multiple beneficiaries on a single account or insurance policy. If one of the beneficiaries predeceases you and you then pass, the family of the deceased beneficiary could be disinherited, which is probably not your intent.
Another issue with multiple beneficiaries is potential negative tax consequences and inheritance issues. For example, if you name your two adult children as beneficiaries of a $500,000 RRSP or RRIF, each would receive $250,000 tax-free. However, the $500,000 is considered fully taxable income to your final estate, meaning your estate owes $250,000 to the government. This could impact distributions and family dynamics significantly.
There are other scenarios where naming a direct beneficiary is discouraged, such as secondary/contingent beneficiaries and cases where beneficiaries are exposed to creditors or marital breakdowns.
Alright, that’s all for today. I hope you found value in today's show. Estate planning can be difficult to discuss, as it involves accepting your own mortality. However, not making a plan will only hurt your loved ones more after your passing.
Your action items for today:
1. Review your retirement account statements. Do you have a minor set up as a beneficiary? Do you have a non-spouse as a direct beneficiary? Do you have a disabled beneficiary named?
2. Dust off your will and review it. Are the intentions of your will negatively impacted by a direct beneficiary? Are there children from a previous marriage that should be considered?
3. Set aside time to update your estate planning documents. Although doing nothing is an option, the repercussions can have severe financial and emotional stress on your loved ones when you are gone.
If you enjoyed the show, please subscribe and leave us a review on your favorite podcast app.
For more content, join our weekly Retiring Canada newsletter by clicking the link in the description.
And remember, when it comes to your retirement, don’t take chances.
Make a plan so you can retire with confidence.
All comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of Harbourfront Wealth Management. While every attempt is made to ensure accuracy, facts and figures are not guaranteed, the content is not intended to be a substitute for professional investing or tax advice. Please seek advice from your accountant regarding anything raised in the content of the podcast regarding your Individual tax situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.