The article “Why cash isn’t always the best gift, especially when it comes to your kids” was originally published in Financial Post on December 29, 2021. PHOTO BY FRANCIS RACINE/CORNWALL STANDARD-FREEHOLDER/POSTMEDIA NETWORK FILES.
Instead of giving your children a gift of cash, pay an expense for them.
Research has shown that when young children give a gift to someone, it makes them even happier than when they receive a gift themselves. Parents know this feeling well, especially at this time of year, when they shower their kids with presents. Those inclined to give cash, however, may want to think twice, even if their children are all grown up.
Opening a bank account for a young child is a good idea but leaving those savings sitting in cash may not be best. One hundred dollars per year added to a chequing account will be $1,800 after 18 years. In a savings account, it could amount to $1,981 at a one per cent interest rate. Socked away in stocks for 18 years at a six per cent return, the same savings could be $3,474 — nearly twice as much as the chequing account.
You can open an informal trust account at a brokerage to buy mutual funds, stocks, or exchange traded funds for a minor child, but beware the attribution rules. If an adult gifts money to a child, grandchild, niece, or nephew who is under the age of 18, and that minor invests the money, any income earned subsequently is attributed back to the adult. Income in this context is defined as interest or dividends, and the attribution requires that income is reported by and taxed to the adult on their tax return. Capital gains, however, are not subject to income attribution. So, it can be more tax efficient for a minor to buy stocks or growth funds than GICs and Canada Savings Bonds.
Most people should not have trust accounts for their children unless they have a lot of taxable non-registered investments. In a case like this, a formal trust can be established with a lawyer and funded using a prescribed-rate loan to avoid attribution and have the income taxed to low-income minors by giving them the income or spending it on their behalf. Formal trusts also provide greater control and protection after a child has reached the age of majority and would otherwise have access to an informal trust account for them.
Most parents and grandparents would be better off opening an RESP in their own name for their minor children or grandchildren instead of putting money in a bank or trust account in a child’s name. RESP investments grow tax-deferred but more importantly contributions qualify for a 20 per cent Canada Education Savings Grant on up to $2,500 in annual contributions (plus up to $2,500 in previously missed contributions). The 20 per cent instant return on investment makes an RESP superior to an informal or formal trust and is a great way to save for college, university, or trade school costs in the future.
Another alternative to giving cash to a child is to keep the money and instead put it in your own TFSA. It could be easier than investing the funds in an informal trust account or establishing a formal trust, plus the income and growth are tax free. You could buy an investment that differs from your own TFSA investments to distinguish the savings from your own, or instead open a separate account altogether.
For adult children, there are reasons to think twice about a gift of cash as well. It is common for parents to give money to their children to help with a home down payment. In fact, CIBC recently estimated that nearly one third of first-time homebuyers across the country got a gift from their parents and the average gift was for $82,000. In expensive cities like Vancouver and Toronto, the average gifts were a whopping $210,000 and $175,000, respectively.
There are two reasons for parents to think twice about large gifts to their adult children. First, a parent should be careful about overcommitting and giving money they may someday need back. If the gift is necessary for a child to qualify for their mortgage, that is a good indication they are already stretched financially, and they could be hard-pressed to make their mortgage payments let alone repay you if you needed the money.
Second, a gift to a child could be exposed to a division of assets in the event your child has a relationship breakdown like a separation or divorce. The rules differ from province to province and based on other factors, but some of your contribution to a matrimonial home could end up going to your ex-son- or daughter-in-law. Instead of a gift, you could consider a loan, even if the loan is at 0 per cent interest and there are never any repayments (only upon demand or upon your death, for example). At least the initial capital could be protected especially if the amount is significant. However, some banks require gift letters from parents to qualify their children for a mortgage, and inter-family loans can be awkward with in-laws.
I am a big fan of parents helping their children indirectly. So, instead of giving them a gift of cash, pay an expense for them. That expense could even be an expense they may not otherwise incur. For a spendthrift, it may be paying for life or disability insurance premiums for them or contributing to an RESP for their children (your grandchildren). For a child who is frugal but deserves an indulgence, consider a gift certificate for a spa or a housekeeper — something they may not otherwise splurge on themselves.
Another alternative to giving cash is to give assets. If a parent transfers capital assets like investments or a cottage to a child, that transfer generally takes place at fair market value and could trigger capital gains tax for the giftor. That consideration aside, it may be a child is more likely to keep their 10 bank shares invested than to avoid the temptation to spend $1,000 of cash.
So, full disclosure here. I grew up getting a $50 bill in a Christmas card from my Nana and Papa every year. I got a cheque from my parents to help me with my first home down payment. My teen and pre-teen kids got cash in their stockings this year for the first time. And I am personally in favour of giving money to kids (and charity) while you are alive instead of solely upon your death.
Giving to your kids is okay, within reason, so long as you do not compromise your own financial security. The point is there may be better ways to give to them beyond putting cash in their bank account or possibly even preferable to giving them money directly or without consideration for tax, family law, or other issues.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.