Your long lost uncle John passed away and left you a rather large inheritance. You know that receiving inheritance is tax-free but you wonder if you should put some of it into your RRSP or your spouses RRSP.
Why Shelter The Inheritance In An RRSP?
If the inheritance received was tax-free, why bother placing it inside an RRSP? The reason is simple: If you have taxable income in the year you received your inheritance, you can reduce your income taxes on your other income by making the contribution. In addition, any future investment income earned from the funds held inside the RRSP grows tax deferred.
Contribution Up To Your RRSP Contribution Limit
If you have RRSP contribution room carried forward from prior years, you can make a lump-sum contribution to your RRSP. If you are married, you may instead contribute to your spouses RRSP up to your annual contribution limit. You can contribute in any combination to your RRSP or your spouses RRSP up to your annual RRSP contribution limit.
With spousal RRSP’s, your objective should be to ensure that both your RRSP’s have the same amounts in them. When you both reach retirement, your income should be the same. Of course, this makes sense when one spouse currently earns more than the other.
Carry Forward Your RRSP Deduction
The amount you contribute to your RRSP is capped by your RRSP contribution limit. However, there is nothing requiring you to deduct any or all of your RRSP contributions and you can carry them forward if you expect your income to be higher in a following year.
Similarly, if you have an RRSP contribution limit that is higher than your annual income, it may make sense to contribute up to your RRSP contribution limit, but only deduct enough to reduce your tax payable to zero.
Sandra is single with no children and has annual employment income of $40,000. Her RRSP contribution limit is $55,000. She received an inheritance of $100,000 and contributes $55,000 of it to her RRSP. How much should she deduct?
At first blush, Sandra may be included to deduct $40,000 this year and the remaining $15,000 next year. Her 2009 taxes would be zero and she would save $3,700 on her 2010 taxes. However, she has personal tax credit that must be used in the current year that could offset any taxes to zero.
Assume Sandra’s only personal tax credit federally is the basic personal amount of $10,320 for 2009. In this case, she should only deduct $30,000 this year and $25,000 next year. This way her 2009 income tax bill will still be zero and her 2010 tax savings would be about $6,000.
The above example shows that you should maximize your RRSP contribution but only deduct enough to reduce your tax payable to zero.