Ask a Planner
I attended a financial planning seminar and the presenter said you’re taxed so high on RRSPs when you die that your kids are only going to get half of it, which I already kind of knew. So, if you put it into these segregated funds, then you don’t pay tax. Should I be doing this? I am a 69-year-old widow, living in Ontario with $840,000 in RRIFs, and 136,000 in a TFSA. I have one daughter and I am a conservative investor spending about $60,000 a year.
—Pam
Hi Pam — it sounds like the seminar focused on a real issue: the tax hit that can apply to RRSPs and RRIFs at death. You are right that the tax can be substantial, and that can significantly reduce what your beneficiaries receive. However, shifting your RRIF into segregated funds isn’t automatically the best solution. This is a decision that benefits from careful modelling because several moving parts affect the outcome: immediate tax, ongoing fees, probate, creditor protection and the impact on your living income.
At death, the value of an RRIF or RRSP is generally added to your income for the year and taxed accordingly. For an $840,000 RRIF, that can translate into a tax bill that materially reduces the amount left for your daughter. That’s the problem the presenter was highlighting. Segregated funds are often pitched as a way to avoid that tax burden, but they don’t eliminate taxation — they change when and how tax applies and introduce other trade-offs.
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Segregated funds are essentially mutual funds held inside an insurance contract. They commonly offer features that attract investors concerned about legacy and creditor exposure: death benefit guarantees (often 75% or 100% of premiums), maturity guarantees after a set period (typically 10 years), creditor protection and the ability to name beneficiaries so proceeds can bypass probate.
The downside of seg funds
Those features do have value, but they are not free. The insurance wrapper typically increases the management expense ratio (MER) compared with the underlying mutual funds. That incremental cost commonly ranges from roughly 0.5% to 1.25% annually, depending on the level of guarantees you select. For a large RRIF — such as your $840,000 balance — that could mean an added drag of several thousand dollars every year. Over time, higher fees can materially reduce portfolio growth and therefore the eventual value passed to beneficiaries.
Death benefit resets are a notable feature: when the portfolio reaches a new high, you can “reset” the guaranteed floor so beneficiaries are assured of at least that higher amount. That can be beneficial in a rising market because it locks in gains for heirs. But resets often affect the maturity guarantee, and both guarantees come at a higher ongoing cost.
For many retirees, the maturity guarantee is less compelling. Historically, a diversified balanced portfolio held for a decade rarely ends up below its starting value, so the guarantee may deliver limited incremental value to a conservative long-term investor. Also, you already have some of the practical benefits claimed for segregated funds: if your RRIF is set up with a named beneficiary, the proceeds can often bypass probate and provide similar creditor protection depending on how accounts and ownership are structured.
The practicalities of the transfer
It’s important to understand how tax is actually triggered. Segregated funds do not eliminate RRIF tax. The tax event occurs when you withdraw money from the RRIF. If you collapse the RRIF in one lump sum to invest in a non-registered segregated fund, you will trigger income tax at that time and likely pay a significant portion of the balance to tax. That simply moves the tax from “at death” to “during life,” and you could end up with far less to invest after taxes are withheld.
An alternative is to increase RRIF withdrawals gradually so the account is drawn down over a set period — for example, to be mostly depleted by age 80. That can raise your taxable income while you are alive, but it reduces the balance subject to tax at death and may leave more net value to your beneficiaries. Leaving money inside a RRIF that you don’t need lets it continue to grow tax-deferred, which can make sense if you don’t require the income now.
Moving funds into a non-registered vehicle also changes the tax profile: non-registered investments generate annual taxable income made up of interest, dividends and capital gains. Those taxes reduce compounding. At death, non-registered holdings may trigger capital gains tax on appreciated assets. So while probate and immediate estate tax issues can be mitigated by non-registered or segregated accounts with named beneficiaries, there are other taxes and fees to weigh.
Because the balance of trade-offs is complex, this type of strategy benefits from detailed modelling with a financial planner or tax professional. You want to compare scenarios: leave the RRIF intact, withdraw gradually and top up a TFSA, shift to segregated funds with guarantees, or use a mix of withdrawals and gifting. Each option affects your cash flow, taxes now, taxes at death and the amount ultimately available to your daughter.
If your priority is maximizing what your daughter receives, consider first using extra RRIF withdrawals to top up your TFSA (if you have contribution room). A TFSA withdrawal later is tax-free to beneficiaries. You can also consider direct gifts or funding of tax-preferred vehicles your daughter might use — RESP for education or an FHSA for a first home — or supporting mortgage repayment. These approaches can reduce the size of your taxable estate while keeping the tax impact manageable.
Finally, make sure any strategy preserves the income you need to live comfortably. Some people choose to reduce the size of their estate intentionally — travel, give more gifts while alive, and enjoy retirement. In many cases, the best “estate planning” is to spend more on experiences and family, reducing the tax burden at death while improving quality of life now.
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