Should you invest an inheritance in an RRSP or a TFSA?

An example will help put this idea into context. Say you had $10,000 left over to contribute to a TFSA or RRSP. If you place the complete amount right into a TFSA and it grew at 5% per 12 months, it could be value $16,289 after 10 years. You could withdraw it, pay no taxes, and spend that $16,289.

By comparison, in the event you put $10,000 into an RRSP and are in a 30% tax bracket, you may get your investment plus a $3,000 tax refund, meaning you may initially come out ahead. If we assume you place $3,000 right into a TFSA and it grows at 5% per 12 months for 10 years, a decade later you’ll have $16,289 within the RRSP and $4,887 in a TFSA.

At first glance, the RRSP appears to be a greater final result. However, in the event you were also in a 30% tax bracket if you made the RRSP withdrawal, you’ll only have $11,402 after taxes. Combined with a tax-free withdrawal of the $4,887 from the TFSA, you’ll have the identical $16,289 available as in the event you had put the whole $10,000 into the TFSA in the primary place.

Project your income in retirement

Most people find yourself in a lower tax bracket in retirement, but not everyone, Kate. People with low incomes before retirement could have a better likelihood of remaining in the identical income bracket.

So in your situation, it could be that your spouse should contribute to their RRSP, for instance, but you should not contribute to yours, for instance. You have to attempt to project your future income while also considering other sources of retirement income similar to the Canada Pension Plan (CPP) and Old Age Security (OAS).

If one in every of you dies early, the survivor could also be in a better tax bracket and all income will probably be taxed on a tax return. And in case your future income approaches the OAS clawback limit — $90,997 in 2024 for OAS recipients — that may increase your effective tax rate on RRSP withdrawals by 15%.

An OAS recipient may pay greater than 55% marginal tax in retirement (or greater than 62% tax in Quebec). That’s greater than a working-age taxpayer making thousands and thousands.

Be careful when posting to registered accounts

So the moral of the story, Kate, is to proceed with caution. The spousal RRSP idea could be idea to your higher-income spouse. If you may have quite a lot of RRSP room, consider deducting the contribution over a number of years.