The Benefits Of Beneficiaries

You work hard and save your money so that when you retire, you still have the income to do the things you want to do, and maybe save some money for your funeral and for your heirs or charities or the care of your pet parrot. There is a vast library of articles about estate planning, but have you looked at your beneficiary designations lately? If you have designated everything to flow to your “estate” and expect your executors to sort it out, read on. There are advantages to naming specific beneficiaries.

This article is intended as general information, and your personal circumstances may vary. None of the following information is intended to be financial advice, and you should always consult a lawyer, accountant or financial professional for specific advice about your personal situation.

What Is A Beneficiary?

The named beneficiary is the person or persons who will receive your money when you die. You can name one person, a bunch of people (and hope your executor has Kevlar and strong negotiation skills) or your estate. You can name a primary person and then a backup or “contingent” beneficiary, so if person A dies, the funds automatically go to person B without needing to change your Will. You can name a minor beneficiary, with someone to act as trustee until the beneficiary reaches the age of majority (or older) in your province of residence. This also applies if you have an adult with disabilities who will need support.

Naming an actual person as a beneficiary for things like bank accounts, registered funds, and life insurance means those funds can be paid directly to the named beneficiary without going through probate. It’s faster and usually more seamless, and those funds do not form part of the estate for tax and probate purposes.

Now here’s where it gets tricky. If you name the beneficiary as “estate”, then all bets are off, as those funds become part of the general estate and must wait for a Will to be probated. That also means that all those funds are lumped together for the estate fees and taxes and other fun things.

Life has a way of throwing curveballs, and beneficiary designations (and potential trustees and executors) can change over time. Relationships end, people die, and friendships change; what made sense when you originally made the choices may not make sense any longer. When was the last time you read over your Will (if you even have one)?

It’s a good idea to check your beneficiary designations periodically. It’s not good enough to change your designation in the Will and call it a day. You need to check things like your pension, Registered Retirement Savings Plan (RRSP) and life insurance because none of those disbursements must wait for the Will to be probated (although most financial institutions prefer to receive a copy of the Will as well as the death certificate). The named beneficiary is entitled to claim the funds. (pension funds have specific rules for death benefits if you have a spouse.) Once more, for the people in the back, the Named Beneficiary is entitled to claim the funds, and if you forgot to take the former love of your life off your life insurance, they could be literally laughing all the way to the bank before your new family finds out. And good luck getting the money back, especially if you never quite got around to finalizing the divorce. It happens more often than you think.

While you are rifling through your safe or filing cabinet to check those designations, create a master list of your various accounts, the account number, financial institution and address. That way, your executor has all the information necessary to start the business side of the death settlement.

A Word About Irrevocable Beneficiary

In the words of Inigo Montoya, “You keep using that word. I don’t think it means what you think it means.” What is an irrevocable beneficiary? In simple terms, it means the beneficiary designation cannot be changed without written permission from the beneficiary (unless they are dead, in which case a death certificate will work in lieu of a signature.)

Revocable/irrevocable beneficiary designations are most familiar in the life insurance realm, however you can name an irrevocable beneficiary on any financial product that allows you to designate a beneficiary. 

One of the most common irrevocable beneficiary situations occur as part of a marriage dissolution when a life insurance policy remains in the former spouse’s name (or the children of the first marriage) as part of the equalization of assets.

But there’s a catch. By designating an irrevocable beneficiary, you are, in fact, transferring ownership to that beneficiary. You may have had the best intentions in making your three-year-old your irrevocable beneficiary on your RRSP to keep the money out of the grubby paws of your former love, but if down the road you need the funds in that RRSP, you are out of luck.

The minute you ticked the irrevocable box, you ceded ownership to the crayon-wielding toddler watching PAW Patrol. You cannot touch the funds without the signature of the irrevocable beneficiary, who cannot give consent because of that messy little thing called contractual capacity. Even if your little genius can sign their name, you are still out of luck until they reach the legal age of majority in your province of residence.

It’s messy and convoluted to un-designate an irrevocable. That’s why you must specifically tick a box to designate a beneficiary irrevocable (except in Québec when it’s automatically irrevocable unless you designate it revocable.)

Unless a judge in a court-ordered decree has told you to designate the beneficiary irrevocable, it’s generally a bad idea. Your future self will thank you.

Creditor Protection

As the pandemic taught the world, life can change rapidly, and sometimes bad financial things happen to good people. When that happens, you may find that people who were initially happy to give you money (credit cards, loans, mortgages) or obligations you may have fallen behind on (spousal or child support) may seek ways to get their money back. That often involves court, court judgements and then seizing assets.

A beneficiary designation can offer some degree of creditor protection. A beneficiary designation to the spouse, child, parents, or grandchild of the account or policy owner is considered a “family class” or “preferred class” beneficiary and gives some creditor protection.

An irrevocable beneficiary designation transfers ownership to the beneficiary and protects the asset from creditors. (although an irrevocable “estate” designation would probably be challenged if it wasn’t flagged when the account was set up in the first place since an estate does not have contractual capacity.)

The courts frown upon last-minute beneficiary designation changes, so it is imprudent to email your change form on the way to speak with your bankruptcy trustee. Besides, the courts have seen it all, heard it twice and will look for shady shenanigans.

Funds such as life insurance and registered retirement accounts are exempt from the clutches of creditors. However, if you cash out the life insurance for the cash value, it’s fair game. A creditor cannot force you to cash out a policy or a retirement account. CRA, however, can seize the proceeds of your bank account, so if the funds hit your account, it’s fair game.

Taxes

One big advantage of naming a beneficiary for life insurance, retirement products and other financial products is the funds can be paid directly to the beneficiary. The funds do not form part of the “estate”, and the value is not included in the calculation of probate fees or estate taxes. The beneficiary can apply directly for the proceeds, and they can be paid directly. Depending on the value of your estate, that can add up to huge savings.

Expediency

Death is expensive. Even a simple Will can take a while to make its way through probate court, and in the meantime, your remaining family members (or pet parrot) have continuing expenses, and funerals are not cheap. One advantage of naming a beneficiary to your life insurance or registered products is barring any complications, if the required documentation is provided, death benefit payments can be processed quickly. That provides less stress for your remaining family members, who don’t need to worry about keeping the lights on and a roof over their heads, especially if your death was unexpected.

Estate

What if you designate all your beneficiaries as “estate” and let the terms of the Will (and trusty executor) settle everything? It might seem like a simple solution, but it can be complicated. Nothing is paid to anyone from estate proceeds until the Will is probated. Then, there is a hierarchy of payments. All your beneficiaries will have to wait until all the funeral, estate and outstanding debts (including probate fees and taxes) are paid before they receive their share, if there’s anything left.

Secondly, any creditor protection disappears if you do not have a preferred class beneficiary. While a creditor cannot force you to liquidate assets, if you happen to receive the proceeds, they are no longer protected because they are considered part of your assets.

Pension plan legislation stipulates that a death benefit must be paid to the spouse of the annuitant, whether you designate a beneficiary or name the estate as beneficiary. Remember that scene of the spouse who is still legally married to you but one or both of you have moved on? It can get awkward and messy if you have a legal spouse and a common-law spouse, and both apply for the death benefit. And even if you designate the beneficiary as “estate” for your pension plan, pension legislation supersedes that. Many compliance officers in insurance companies have had to make an emergency chocolate run because a routine death benefit claim got ugly when the Will arrived.

If you have registered accounts such as RRSP/RRIFs, Canada Revenue Agency (CRA) looks at the value of the funds on the date of death and pretends you cashed them and adds the market value to the value of your assets. 

The exception to this is a “spousal rollover” provision, which allows the spouse to transfer RRSP/RRIF funds, and locked-in pension funds that are not eligible to pay a pension yet to the spouse’s account without cashing the account in and commuting the value.

If you designate the beneficiary as “estate”, you could lose that spousal rollover provision since there is no spouse named beneficiary. CRA might change their mind if you have a designation in the Will, but in the meantime, the funds are off-limits. And CRA is not known for their lightning-quick responses unless you owe them money.

Conclusion

While it might seem like a simple solution to name a beneficiary in your Will, designate individual accounts to an estate beneficiary and let your executor parcel out the inheritances, it can be expedient and make economic sense to designate beneficiaries on certain financial holdings. It can save stress, fees, and taxes for your loved ones at a time when they are generally dealing with enough of all of those things. A financial professional with estate knowledge can help you figure out the plan that makes the most sense for your personal situation.

Lisa MacColl is an Ontario-based writer who specializes in B2B and B2C communications, as well as investments, insurance and financial topics. She has also written general interest and parenting articles, and her novella, “Cannoli” is available on Amazon.