Saving for your Child’s Education with an In-Trust Account
This
article was written by Karen Mitzel and reproduced from Canadian Money Saver,
November, 2000.
WE ALL WANT THE BEST FOR our children and that includes a post-secondary education. The cost of a four-year degree (including books, rent, food, etc) in eighteen years is estimated to be over $100,000. It's a financially challenging situation to face, especially if these costs are multiplied by extra children.
When you consider saving for a child's post-secondary education the majority of people immediately think of. RESPs or Registered Education Savings Plans.
However, there is another option. It is
called an "in-trust account", which is an investment account opened
in your or your spouse’s name but held in-trust for the minor child-(If you
provide the cash for the account, you should not be named as an adult trustee.)
The objective of this account is to save money for your child's education and
at the same time enjoy substantial tax savings.
In-trust accounts are best suited to growth investments because any capital gains in the account are taxed in your child's hands. Therefore, because tax is paid on only 2/3 of the capital gains, your child can earn the basic personal tax credit of $7,231, plus an extra $3,566. That is a total of $10,797 per year of non-taxable income.
For instance, 500 Canadian Pacific (CP) shares purchased at $30 per share and later sold for $40 per share gives your child $10 per share or $5000 of income upon which she doesn't have to pay tax. Had you purchased those shares you would pay taxes on $3333 of income.
If you are in the $60,010 to $75,580 tax bracket you would be paying 24% federal and 48.9% provincial tax on the capital gains earned depending on your province of residence (example given for Saskatchewan). This would result in a tax bill of approximately $1191. However, your child is able to earn this money without paying any taxes and keep the $1191 for reinvestment in her account. As a final result more income is available for reinvesting and your child's money compounds more rapidly than in your hands.
After 18 years of earning $10,797 per year of non-taxable capital gains your child has a substantial education fund of $192,546. If you earn $10,797 per year on capital gains and are in the $60,010 to $75,580 tax bracket you would pay a total of $3,822 per year in taxes. The yearly savings would only be $6,975, resulting in a total savings of $123,750 after 18 years. That is a difference of $68,796 between an in-trust account for your child and you earning the same amount of money in your investment account. It's a staggering difference.
There are a few things to consider when planning to establish an in-trust account. First, the amount gifted to your child is not considered to be tax deductible. Only when your child begins earning income in the form of capital gains is the money a tax savings, for the child and not for the parent. Enjoyment comes from watching your child's income grow at a substantially higher and faster rate than you, as an investor, could realize. (The child must be named and the transfer to the child's account is irrevocable.) Secondly, interest or dividend bearing investments can be placed in an in-trust account but any tax savings will be lost because interest and dividends are taxed in the hands of the individual who made the gift. It makes little sense to gift a $5000 GIC at 5% interest because your child will have no income in the form of capital gains and the $250 per year earned in interest will form part of your taxable income.
Another word of caution. Don't buy speculative investments for your child because you hope to cash in on large capital gains. Stick to the tried and true growth investments. These are investments that are medium risk, have aggressive management, a lower dividend payout and have the potential for above average growth in earnings. On the downside, there is some risk and they do have a higher price volatility, although this makes them a better bargain when they are low in value.
As an added bonus, the money earned by your child in an in-trust account doesn't have to be spent on education. There are no restrictions on what the money is used for as long as it is spent on or by the child. The stated child (beneficiary), only, has the right to the monies unless more than one beneficiary is named (on a percentage basis) in a single account. If this rule isn't adhered to, the capital gains will be taxed back in the hands of the giftor.
There are lots of blue chip stocks that are bargains begging to be purchased and in the long term will give your child the money needed for a first-class education. They will also give you less stress now and in the future because the investments are relatively risk free. You can rest assured that the money will be there for your child's education.
Editor's note: Check with your tax advisor to determine the type of investments that can be held in an in-trust account as they differ between provinces. A formal trust can be used to avoid investment limitations.
Question:
We have in-trust accounts (holding dividend
mutual funds) for our children. These accounts are funded entirely by Child Tax
Credit monthly payments from the federal government. The sales rep has
indicated that when the children turn 18, the in-trust account is closed, and a
new account is opened in the child's name. At that time, all accrued capital
gains are triggered through this action, with the resulting T3/T5 slip. His
information from his company is that the capital gains are taxable to the
trustee. My understanding has been that Child Tax Credit payments and
investment income resulting from those payments are not taxable.
G.B., Edmonton, AB
Answer:
The attribution rules generally require that income earned by property you transfer to your child be taxed in your hands until the year in which he or she turns 18. Capital gains realized by the property are taxed in the hands of your child, regardless of age. In-trust accounts are usually set , up to take advantage of the exception for capital gains and will, therefore, typically consist of equity funds and/or stocks.
Child tax benefit payments are specifically excluded from the attribution rules. As long as your in-trust account is funded entirely from child tax benefit payments, any income or capital gains should be taxed in your daughter’s hands. This includes any capital gains realized by the in-trust account when the property is transferred to your daughter when she turns 18.
To the extent that your daughter's income does j not exceed the basic personal amount ($7,231 for 2000), it will not be subject to tax. If the taxable capital gain resulting from the transfer will exceed this amount, it would therefore be beneficial to trigger it over a period of years, assuming this is possible. The inclusion rate for taxable capital gains has been reduced from ¾ to b, for dispositions occurring after February 27, 2000.
Peter Coles, H&R Block, Calgary
