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Informal In-Trust Accounts

I received an email from Leah the other day asking what are some options for investment accounts for children.  Right away, I thought about RESP accounts, however, those aren't for Leah as they are too restrictive.

I can see the new Tax Free Savings Account (TFSA) being an alternative to the RESP, however, the rules haven't been set in stone yet.  The next best option may be an Informal In-Trust Account (or Informal Trust Account).  As I don't have any real experience with Informal Trust Accounts, here is a basic primer based on some quick research.

The Basics

  • An informal in-trust account is an investment account that is opened for a child (beneficiary).  Once the beneficiary turns the age of majority (determined by province), the account automatically gets transferred to his/her name.
  • These accounts can be opened at most discount brokerages in Canada and can include stocks/ETF's, bonds, mutual funds, GIC's or cash.
  • These accounts cost much less to setup than a Formal Trust (used in larger balances, inheritances etc).

The Upside

  • No contribution limits.
  • Anyone can contribute.
  • No restrictions on how the beneficiary spends the money (unlike RESP's). 
  • Capital gains taxed in the hands of the beneficiary.
  • Second generation income (ie. reinvested dividends that produce dividends) taxed in the hands of the beneficiary. 

The Downside

  • No government matching, thus not ideal for education fund.
  • First generation dividends/interest taxed to the contributor.
  • The beneficiary will receive the money at the age of majority and can spend it as he/she pleases (regardless of the trustees wishes)

Conclusions 

If your thinking about investing on behalf of your child, you need to ask yourself a key question.  What is the purpose of the account?  If it's simply an investment account so that the beneficiary will have a future nest egg, then an informal trust account may be a good solution.  However, if the purpose of the account is for education, then the Registered Education Savings Plan (RESP) would be a better option as the government gives you free money to top up your contributions. 

To add to this, there may be new legislation that will allow RESP contributions to be a tax deductible expense (like an RRSP contribution).  This would give the RESP camp a huge advantage over other types of accounts in saving for their child's education. 

Disclaimer: Note that this is a very basic primer of Informal In-Trust Accounts.  More due diligence is required if you plan on opening this type of investment account for your child.  Special tax considerations are required when opening this type of account, please consult an accountant for your specific situation.

photo credit: j-e-m-s (dos chicas)

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 18 comments… add one }
  • cannon_fodder March 20, 2008, 10:29 am

    What about when the child wants to invest their own money? One child I know has received thousands of dollars over the years from a big family for bdays and Christmas. How does one ensure the parent/guardian isn’t hit with a tax on income (assuming that the investments aren’t only generating capital gains)? What is the process to solve this dilemma?

  • Dividendgrowth March 20, 2008, 10:43 am

    Investing money on behalf of your toddler is one of the best things you can do for your kid. If you set up the fund when the child is born the money could be able to compound for two decades before the kid goes to college. Imagine if that’s the retirement fund for the kid..

  • WhereDoesAllMyMoneyGo.com March 20, 2008, 11:13 am

    Hi FT – the RESP bill in question was killed last week in the house of commons.

  • Curious March 20, 2008, 12:29 pm

    I’m reading up on informal trusts because my parents have set one of for my children. As I understand it, the income from the trust then pays into the RESPs. Does that sound right?

  • cnidog March 20, 2008, 1:53 pm

    My financial planner recently told me that if you have a couple of rental properties you could incorporate a small business. I think that you could also hold investments like stocks, bonds, etc. in that company. Then, when your kids hit 18 and are ready to go to university or on that round-the-world trip, you make them shareholders in the company and pay them dividends. In addition to being able to guide the investments while they are growing up, they will be favourably taxed because the payouts are dividends. Plus, if it looks like they will just throw the money away on parties, you can stop paying them and keep the money for yourself. I don’t have many details on this, but it sounds like it would be worth exploring if you have the right type of investments that would allow you to incorporate a business.

  • FrugalTrader March 20, 2008, 4:15 pm

    Canon, I think that this type of account is probably the best bet if you want a generic investment account on behalf of your children. With regards to taxes on invested gift money, I would need to do some research on that one.

    Preet, thanks for the info, I just fixed the article.

    cnidog, careful with incorporating with passive income being generated within the corp. Passive income taxed at the highest rate within a corp, whereas it’s taxed much less under personal.

    curious, I will have to do more research on the rules when withdrawing from an informal trust. Why not get your parents to directly contribute to the RESP account?

  • Ed Rempel April 4, 2008, 12:29 am

    Good article, FT.

    The critical issue in deciding between “in-trust” accounts and RESP’s is one question: If the child does not ever go to post-secondary school, does the parent want them to have the money anyway (a home down payment, wedding or “get started in life” fund?, or does the child get the money only if they go to school? If the parents want the child to get the money anyway, than In-trust accounts are better (unless the parents are very sure the child will attend university). If the money is only for education, than RESP’s are better.

    The RESP grant is nice, but RESP’s are not friendly for giving money to kids for anything other than post-secondary school.

    Possible tax savings on in-trust accounts can also partially make up for the RESP grant. In-trust accounts, if handled properly, can result in no tax at all, since you can trigger capital gains periodically to stay below the child’s personal exemption. RESP’s might result in some tax if the student has a summer/part time job as well as larger RESP withdrawals.

    Ed

  • Baillie November 27, 2008, 11:21 pm

    Hi FT,

    Your article is very interesting. I was wondering if there are any costs associated with setting up an in-trust account and how much would they be?

    Thanks,

    Baillie

  • FT FrugalTrader November 27, 2008, 11:36 pm

    Baillie, to my knowledge, an informal trust can be opened at most discount brokerages without any extra fees etc. A formal trust account however, I believe is a legal entity which requires extra costs.

    Disclaimer though, I’ve never opened a trust account before so my knowledge about the subject is limited. Maybe more experienced readers can chime in.

  • Ed Rempel November 28, 2008, 12:26 am

    Hi FT,

    An informal trust is just an investment account registered in the name of an adult “in trust for” the child. e.g. Frugal Trader in trust for Mini-Frugal. They are called “ITF” accounts.

    Since you need to be 18 to legally own an investment, anyone under 18 needs to have the account in the name of an adult.

    There is one error in your article. Income is taxed to the parent. Dividends and interest are taxable to the parent, but capital gains are taxable to the child. Therefore, ITF accounts should focus on earning capital gains.

    The account does not automatically change to the child’s name at 18. This is good because how many kids at 18 would be smart with a generous investment account? It is changed when the parent signs to have the name changed. This means the parent can effectively control the account, even when the child is an adult.

    Ed

  • Steve Bay December 20, 2008, 5:39 pm

    I set up an In-Trust account for my son 16 years ago. Now he is turning 18. When I asked the Mutual Fund Co. what the procedure was for transferring the account over to his name, they said the units would have to be sold & re-purchased by him (the child), and I (the parent) would be on the hook for 16 years of capital gains. That sounds ridiculous as it defeats the whole purpose of an In Trust account. Can you shed any light here ?
    Steve

  • mybartmart June 25, 2009, 10:24 am

    what about buying Canada savings bonds for your children in their name? I am thinking of doing this every year for ours.

  • PJK April 5, 2017, 12:35 am

    Although in-trust accounts are typically set up for children, this is not a condition. In my case, I act as trustee on behalf of an elder sibling who gained an inheritance that would otherwise negate her partner’s disability pension. The beneficiary can draw a limited amount from the trust per year to offset living expenses, before those pension benefits are clawed back. I believe in such a case, all interest, dividends, and capital gains incurred by the trust are taxed in the hands of the beneficiary. However, I am new to this…

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