How to prepare for an inheritance

Receiving an inheritance can bring up a mix of emotions — and a long list of decisions. Taking time to pause, get organized and understand your options can help you make choices you’ll still feel good about years from now.

The good news is that you're not alone. Right now, there's a "great wealth transfer" underway in Canada and elsewhere. Trillions of dollars in wealth will transfer from baby boomers to younger generations over the next 10 to 20 years.

What receiving an inheritance really means for your finances

Inheriting money can be life-changing — a financial turning point that may create opportunities to strengthen your financial position, depending on your decisions and circumstances. But if handled poorly, whether through inaction or impulsive decisions, even a large inheritance can be quickly depleted without a thoughtful plan. If you've recently received, or anticipate receiving, a substantial inheritance, you need a structured, practical framework to help you navigate this major life event.

These five steps — pause, assess, understand the tax picture, plan and protect your legacy — are part of the financial and emotional preparations you can consider   before making any major moves.

Step 1: Pause before making major decisions

A cooling-off period of 30 to 90 days can give you time to process the idea of the inheritance and avoid making major decisions while emotions are running high. Taking a pause helps ensure that your first decisions come from a place of clarity rather than reacting to your initial emotions.

Learning about an inheritance and receiving it are often two distinct stages separated often by two or more years. Before assets can be distributed to beneficiaries, the executor generally needs to apply for probate, if required in the province or territory of residence. Probate is a process whereby a legal court validates a person’s will and gives their executor (or a liquidator in Quebec) the necessary powers to manage the deceased’s estate, deal with assets and financial institutions, pay debts and taxes, and then lastly distributes the net estate to its beneficiaries.

Depending on the province or territory and the complexity of the estate, obtaining probate can take anywhere from several weeks to several months, and longer when complications arise.

What should I do immediately after learning about an inheritance?

Start by gathering information to confirm your role, find out who’s handling the administration of the estate and discover what you’re inheriting. Here's what to look into:

• Ask if you can get a copy of the will and confirm your role.

• If you're a beneficiary, understand what you're inheriting under the terms of the will. This could be cash, property, proceeds of a registered account¹ such as Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs or RSPs at Tangerine) or Registered Retirement Income Funds (RRIFs or RIFs at Tangerine), or non-registered investment accounts, private company shares or interests in a business, or family heirlooms. Each of these assets carries different tax and financial planning implications.

• If you're an executor, understand your role and responsibilities and consult with an estate lawyer if you have any questions.

Step 2: Take stock of your current finances

During the cooling-off period, review your finances to get a clear snapshot of where you stand. Compile everything you own minus everything you owe to determine your net worth and calculate your net cash flow by subtracting all outflows and expenses from all sources of income.

Consider the following to determine if you have foundational gaps in your finances:

Do you have high-interest debt?

High-interest debt, such as credit card balances, personal loans and other consumer debt, carries interest rates that can outpace typical investment returns, so paying down this type of debt is often the top priority. No longer having to service these debts will improve cash flow and eliminating them will boost your net worth.

Do you have emergency savings?

A rule of thumb is to have three to six months of living expenses in liquid savings to get you through difficult financial times. In addition, a small rainy-day fund ($500 to $1,000) can provide added security for those unexpected expenses that pop up.

Is your current investment strategy and retirement plan on track?

Review your retirement savings strategy to see if you're on track to meet your goals. Determine if you've fully utilized your RRSP and TFSA contribution room. Consider talking to an advisor to determine the most tax-efficient strategy for your unique situation.

Do you have insurance or protection gaps?

Life, disability or critical illness insurance is often an additional component of your financial safety net. A large inheritance may change your insurance needs, so consider bringing it up with your advisor.

Step 3: Understand the tax implications in Canada

The next step is to understand how inheritances are taxed in Canada.

Is there an inheritance tax in Canada?

Canada generally does not impose a separate tax simply because a beneficiary receives an inheritance. However, a death can trigger income tax consequences, including the deemed disposition of certain assets, and an estate may earn taxable income before assets are distributed. Who ultimately bears a tax cost can depend on the asset, the beneficiary designation, the will and the estate’s circumstances.

Immediately following death, the assets pass into the estate. Any income the estate earns before it’s distributed to beneficiaries may also be subject to tax.

What are the tax rules for inherited RRSPs and RRIFs?

The rules differ depending on who inherits the account. If the registered account is left to a spouse or common-law partner, a spousal rollover allows for a transfer of the RRSP or RRIF into their own registered account, deferring tax until they eventually withdraw the funds.

Non-spousal beneficiaries don't get that deferral — and the tax liability doesn't follow the money. If the deceased named a beneficiary directly on the RRSP/RIF contract or named a beneficiary for the plan through their will, the RRSP/RIF proceeds will pass directly to that person outside the estate, bypassing probate. But in most cases, the full value, with some exceptions, is still included as income on the deceased's final personal tax return for the year of death, and that tax is typically paid out of the estate's other assets, regardless of who received the RRSP/RRIF funds directly.

If no beneficiary is named, or the estate is named as the beneficiary, the proceeds fall into the estate and are distributed according to the will and subject to probate, if applicable.

What are the TFSA inheritance rules?

TFSA rules are nuanced and have tax implications. A spouse or common-law partner can be named as a successor holder, which means the TFSA and its tax-free status transfers to them directly, with no impact on their own contribution room.

Anyone else named as a beneficiary, rather than a successor holder, receives the value of the account tax-free, but only up to the value at the date of death. Generally, any growth after that point may be taxable, and the funds don't come with any special TFSA room attached. A beneficiary who isn’t a spouse or common-law partner can only put them in their own TFSA if they have contribution room available.

Are there capital gains on inherited property?

If you inherit property, any resulting capital gain (based on how much the asset appreciated while the deceased owned it) is reported on the deceased's final personal tax return and settled from the estate's assets. However, if the property qualifies as the principal residence of the deceased, the principal residence exemption can shelter some or all the resulting capital gain from any tax on death. Once the property is in your hands, the fair market value at the date of death becomes your new adjusted cost base.

Does Canada have a gift tax?

Canada generally does not impose a separate gift tax on a gift of cash. However, transferring investments, real estate or other property may create income-tax consequences, and attribution or other special rules may apply in some circumstances. Obtain tax advice before making a significant gift.

Step 4: Build a financial plan around your goals

Receiving an inheritance is an opportunity to help you reach your financial goals faster, as well as a chance to aspire to new goals. But it doesn't mean you have to create a whole new financial identity. Let your personal values be your guide.

Aligning your plan with long-term goals

An updated financial plan may help you assess how the inheritance could support your existing and future goals, old and new, that align with your new wealth. Identify matters that may require advice from a qualified tax professional or estate lawyer and help make decisions based on a fuller understanding of your financial circumstances and options.

Decide how the inheritance will support your priorities

If Step 2 revealed foundational gaps in your finances, like high-interest rate debt or an underfunded emergency fund, consider using part of your inheritance to close those gaps first, then decide how to put the rest to work toward your short- and long-term goals.

Consider how TFSA and RRSP contribution room fits into your plan

Think about using the unused contribution room in your TFSA. Although contributions are not tax-deductible, any money you earn within your TFSA is tax-free.

Determine whether it makes sense to contribute to your RRSP, given your current income and your expected income in retirement. RRSP contributions can be deducted from your annual income for tax purposes, but any withdrawals from the account are taxable.

READ MORE: How do RRSP withdrawals work?

Investing beyond registered accounts

Once you've optimized investing within your registered accounts, any remaining funds from your inheritance can be invested in a non-registered account. Choose investments that align with your goals, risk tolerance, personal circumstances and time horizon. Tax efficiency, which refers to structuring your investments to keep more of what you actually earn after tax, should also be a consideration. Speak with an advisor about your unique situation.

Using an inheritance toward real estate

If one of your goals is to buy a home, an inheritance can significantly increase your down payment. If you already own a home, you may want to consider paying down your mortgage if it makes sense for your financial situation.

Step 5: Review your own estate plan

Receiving a large inheritance changes your financial picture, which can instantly make your existing estate plan, if you had one, outdated.

Update your will and beneficiaries

Consider asking an estate lawyer whether your will and estate plan should be reviewed in light of the change in your assets.

Review power of attorney documents

Create or update your powers of attorney for personal care and property. These documents let you appoint someone to make decisions on your behalf when you're alive but are incapable of doing so yourself.

Consider creating trusts or making charitable gifts

If you've received a significant inheritance, speak to a trust and estates lawyer to see if a trust structure makes sense for asset protection or charitable giving. For the charitable giving part of your plan, a financial or tax professional can explain options that may provide tax benefits.

How can you manage the emotional side of getting an inheritance?

Many people who receive a financial windfall experience unease or guilt about suddenly having money they didn't earn through work, especially if those close to them are struggling. Requests for financial help and disagreements over money can strain family dynamics. Having an advisor on your wealth management team, in addition to an estate lawyer, can create a buffer for these demands. Hearing "no" from your advisor may land differently than hearing it from you. An inheritance can bring up a mix of emotions, and it’s easy to feel overwhelmed initially. But if you pause before making any major decisions, take stock of your finances, understand the tax implications, build a plan and review your own estate plan, it’s easier to move forward with confidence.