RRSP vs TFSA for Your Inheritance: Which Is Right?

Ask MoneySense

We are a couple in our late 50s with no children. We own our home outright and carry no debt. Both of us will receive pensions in retirement, but my spouse’s pension will be roughly double mine. Our RRSP savings are modest. We have just inherited $200,000. Conventional wisdom suggests putting inheritance proceeds into a TFSA to avoid future taxation, but other sources recommend prioritizing RRSPs and reinvesting any tax refund, especially if retirement income is expected to be lower than current income. Which is the better choice for an inheritance: TFSA, RRSP, or a spousal RRSP?

—Kate

How to invest an inheritance

Kate, the single best step after receiving an inheritance is to pause and re-evaluate your overall financial picture rather than acting immediately. Emotional timing, estate settlement and tax consequences all matter, and a thoughtful plan will often beat a hasty decision. Take time to grieve and to assess your priorities, goals and projected retirement income before committing the funds.

You note that your spouse’s pension will be about twice yours. Keep in mind that Canadian tax rules allow pension income splitting in many cases, which can move up to 50% of eligible pension income from a higher‑income spouse to a lower‑income spouse for tax purposes. This is done on the couple’s tax return for the year in question and can reduce the couple’s combined tax bill by balancing income between partners.

Pension income splitting is a powerful tool, but it is a policy-based tax provision and, like any policy, its future is not guaranteed. That is why a spousal RRSP can remain a useful planning option: it is an established registered vehicle that can help equalize retirement income while providing immediate tax relief to the contributing spouse.

What is a defined benefit?

A defined benefit pension pays a predictable retirement income based on a formula that typically considers years of service and salary history. Many defined benefit plans calculate benefits as a percentage of your average salary over a set period multiplied by years of service. The result is a steady, often inflation‑protected income stream that differs from defined contribution plans, which depend on account balances and market returns.

How do spousal RRSPs work?

A spousal RRSP allows the higher‑income spouse to contribute to an RRSP in the lower‑income spouse’s name. The contributor claims the tax deduction, while the account owner becomes the eventual holder of the funds. This structure can be used to shift taxable withdrawals into the hands of the lower‑income spouse in retirement, thereby reducing combined taxes.

Spousal RRSPs are less prominent now that pension income splitting exists, but they still serve a role. To contribute to a spousal RRSP the contributing spouse needs sufficient RRSP contribution room. For people who participate in workplace pensions, pension adjustments can reduce RRSP room in the following year to keep pension benefits and RRSP contributions equitable across workers.

The best way to use a spousal RRSP

If your spouse has RRSP room and earns significantly more than you, a good sequence is: first, have the higher‑income spouse contribute to their own RRSP up to an amount that makes sense given their tax situation; then consider spousal RRSP contributions. Don’t feel compelled to maximize a large RRSP deduction in one year if that deduction will be much more valuable spread over multiple years.

You can carry forward unused RRSP deduction room, which allows you to time deductions to years when they will produce the largest tax relief. For instance, if deducting a large amount this year would push you into a much lower tax bracket, saving some deduction room for the following year—when your income might be higher—could be more advantageous.

RRSP or TFSA: Which should you contribute to first?

Choosing between an RRSP and a TFSA depends largely on the relationship between your current tax rate and your expected tax rate in retirement. A simplified example illustrates the trade-off:

If you invest $10,000 in a TFSA and it grows at 5% per year, after 10 years it could be worth approximately $16,289, and withdrawals are tax-free. If instead you put $10,000 into an RRSP while in a 30% tax bracket, you receive a $3,000 tax refund. If you invest that $3,000 in a TFSA and both accounts grow at 5% for 10 years, your RRSP could be worth $16,289 pre-tax and your TFSA holding from the refund about $4,887. If you then withdraw the RRSP and pay 30% tax at that time, the after‑tax RRSP proceeds would be about $11,402, and combined with the tax-free TFSA savings you’d again have roughly $16,289—similar to the outcome of having invested the original $10,000 directly into a TFSA.

This shows the importance of expected tax rates now versus in retirement. If you expect to be in a lower tax bracket in retirement, RRSP contributions can deliver a net tax benefit. But if your retirement tax rate will be the same or higher—because of high pension income, Old Age Security clawbacks, or being the sole survivor of a couple—TFSA contributions may be preferable.

Project your income in retirement

Most people do move into a lower tax bracket in retirement, but that isn’t universal. Project both partners’ expected income streams from pensions, CPP, OAS and any other sources. Consider scenarios where one partner dies earlier and the survivor receives combined income on a single tax return, which can bump their marginal tax rate up.

Be aware of thresholds that can sharply increase effective tax rates. For example, if your combined retirement income approaches the Old Age Security clawback threshold, the additional tax on RRSP withdrawals could be substantial. An OAS recipient whose income triggers the clawback can face an effective marginal tax rate much higher than they would expect, which makes careful planning essential.

Contribute to registered accounts with caution

In short: contribute thoughtfully, not reflexively. For your situation, a spousal RRSP could be an effective tool for rebalancing retirement income, but the contributing spouse needs RRSP room and the timing of deductions should be considered. If the higher‑income spouse has ample RRSP room, spreading deductions across a couple of years may deliver greater tax savings than a single large contribution.

Beyond taxes, consider how the inheritance can improve your overall retirement readiness. Dual pensioners often believe they must work until guaranteed pension start dates rather than choosing a retirement date that suits their lifestyle and health. Use this windfall to review retirement timing, income sources, longevity risk and whether you might already be saving more than necessary.