Question from Adam: I’m 31 years old and have questions about what to do with an inheritance. My grandmother passed away in 2015, leaving me with an inheritance of between $100,000 and $150,000 (once the estate closes). I’ve been diligently saving for the past five years and have pretty much maxed out my TFSA as well as making regular contributions to my RRSP to the point where I’ve just about reached my sole goal of reaching the $25,000 limit for the first-time home buyers loan. At the moment, all of my investments are in Tangerine Mutual Funds and I’ve got a chunk of cash in a high-interest savings account for an “emergency fund.“
What on earth do I do with an inheritance? How do I allocate my assets to make sure that I’m taking advantage of the tax advantages offered by registered accounts? Is it time to graduate from Tangerine Mutual Funds to something more … sophisticated?
Shannon Lee Simmons is a financial planner and founder of The New School of Finance in Toronto.
The answer: When people receive large chunks of money, such as gifts or inheritances, there is no one-size-fits-all solution. It’s all about you and your goals.
You mentioned that buying a property is something you’d like to do one day. If you’ve got your tax-free savings account (TFSA) maxed out (assuming $52,000), $25,000 in your registered retirement savings plan (RRSP) and a $150,000 inheritance, you might have enough for a sizable down payment on a home, condo or rental property.
Option one: If you want to buy property, consider these four steps
1. Ensure you can afford it
Without knowing your household income or other obligations, it’s hard for me to guess what mortgage you could comfortably afford on a primary residence or on a rental property that breaks even. However, with more than $200,000 under your belt, you would have some options.
2. Decide if you’re purchasing a rental property or primary residence
You can’t use the first-time home buyers plan if you want to purchase a rental property. If you did want to purchase a rental property, you still have a sizable amount outside of the $25,000 in the RRSP, but just keep that in mind when number crunching.
3. Don’t invest it
If your plan is to purchase a property in the next one to two years, the funds for that shouldn’t be invested since your time horizon is too short. When investing, the longer your time horizon, the more ups and downs, or market volatility, you can handle. On the other hand, the shorter your time horizon, the less market volatility you can handle. You can read more about that here.
4. Keep the money safe
Put the money in a high-interest savings account that is liquid and easy to access as you start your property search. If you can find it, aim for a 2-per-cent annual interest rate – at least this way your nest egg is keeping pace with inflation.
Option two: If you don’t want to purchase a property in the next few years, read the points below.
1. Get clear on your investment time horizon
If you don’t plan to use the money for anything in the next one to two years and you’ve got your emergency account, you can likely handle some market volatility on your assets, so consider investing. Figure out whether you are investing your money for the medium or long-term.
2. Choose your investment accounts wisely
There are three investment accounts you can choose from: non-registered, TFSA and RRSP.
Non-registered investment account
Since you’ve got quite a large amount of money and a maxed-out TFSA and potentially-maxed-out RRSP, you may need to open a non-registered investment account. This type of account is not a tax shelter like the TFSA and RRSP. That means that you will have to pay taxes on any investment income (dividends or interest) in the year they are earned. Also, any investments that you sell that have gone up in value means you’ll have to pay tax on the capital gain. For example, if you bought into an index fund for $100 and sold it for $150, you’d have a $50 capital gain that you’d have to report on your taxes. Read more about capital gains tax here.
The TFSA is a great place to invest since you don’t pay tax on any of the investment income or capital gains like you would in the non-registered account. However, since you’ve maxed out the TFSA already, you can’t put more in this year. You will have to wait and move money from your non-registered, taxable account to your TFSA when you get new room next year.
If your goal is to put a chunk of the inheritance away for retirement and not take it out for any reason before then, consider contributing more to your RRSP. The RRSP is tax-sheltered, like the TFSA, but the contributions you make are also tax deductible. For example, if you wanted to put aside $15,000 for retirement, you could invest it in your RRSP, assuming you had the contribution room. That contribution would lower your income by $15,000 in that tax year, which would likely result in a large refund.
3. Keep investment fees low
I’m a big fan of low-fee, managed solutions like Tangerine Index Funds, robo-advisors and low-cost mutual funds, all of which are also easy to invest in. Typically, these options are appealing to first-time investors because they are simple to use and the investment minimums are low.
However, you’ve potentially got enough assets under your belt to meet investment minimums to work with an adviser if you wanted. Just ensure that you are getting good value for your money. Working with an adviser can be a wonderful thing; they can help to administer the account and make customized financial plans for you on an continuing basis. However, the fees can be high.
My rule of thumb: If you’d like to work one-on-one with an adviser, ensure that the average fees you’re paying are 2 per cent or less. In addition, you may want to shop around for a fee-based adviser. This way, he or she is paid based on a set percentage, not transaction fees or compensation for selling products. Read more about management fees and traditional advisers here.
There is nothing “more sophisticated” about working with an adviser versus sticking with low-fee solutions such as robo-advisors or index funds: it’s about what you want and what makes the most sense for you.