Tips to see
things clearly

Unexpected income is always good news, be it a bonus at work or a gift from a parent. Before you head out the door for that new state-of-the-art television or a trip, here are some strategies to maximize that windfall.

Richard Thaler¹, a Nobel prize-winning professor of financial behavioural science and economics at the University of Chicago Booth School of Business, created the theory of “mental accounting” which looks at how people spend and how they categorize money. People are far more likely to overspend with unexpected money because they don’t count the funds as part of their normal income and expenses; it’s play money, and therefore easier to spend.

For example, someone who receives a $200 increase in their weekly pay may not spend the extra money on a new electronic device, but if they won the same amount of money, they would. When people consider windfalls as part of their income, they are less likely to make impulse purchases.

Invest it

Beat the mental accounting trap by putting the money to work for you while you decide where you can get the best bang for those bucks given your financial situation. It’s much easier to spend money in your wallet or in your debit-friendly bank account.

Instead, put the sum into a Tax-Free Savings Account (TFSA), a guaranteed investment or a money market fund, where it will be harder to get at. Before you invest the funds in your Registered Retirement Savings Plan (RRSP) for the tax savings, remember that RRSP withdrawals are taxed as income at your marginal tax rate and that income tax is withheld at the time of the withdrawal.

Ask an expert

Speaking with a financial advisor can help you prioritize and put the gifted money where it can provide the most benefit for your financial situation. If you have a group retirement plan with your employer, you may be able to contact the service provider to get advice from a financial expert.

Consider your financial situation

What stage of life are you in? If you are saving to buy your first home, putting the windfall towards your down payment may make sense. Do you have high-interest credit card debt? Paying off the cards with the highest interest rates helps both your credit rating and your financial situation.

Are you paying off student loans or do you have a mortgage? Making a lump sum payment goes straight to the outstanding principal. Monthly payments are applied to accrued interest first.

If you are nearing retirement age, it may not make sense to deposit the entire gift into an RRSP. You’ll need to find out whether the taxes you save with the contribution to your RRSP are greater than the taxes you will have to pay when you withdraw from your RRSP in retirement.

You could also decide to max out your TFSA’s unused contribution room. At retirement, the amounts you withdraw from your TFSA won’t be taxed and won’t affect the calculation of income-tested benefits such as your Old Age Security and drug benefits.

Save some of your gift

If you had a major house or car repair, or a sudden illness, how would you pay for it? Setting aside some of the money for an emergency and putting it in a TFSA ensures unexpected costs won’t send you into a tailspin. Your funds will grow tax-free while they remain in the TFSA and there are no tax implications when you withdraw the funds later.

Spend some

Yes, you read that right. While it’s a bad idea to blow the whole wad, keeping some of it as play money and treating yourself makes you more willing to be fiscally responsible with the rest. Don’t go too far, though.