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.
- 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).
- 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.
- 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)
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.
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