The desire to provide financial aid is understandable, but make sure of your own financial position first
By Olev Edur
We all want to help our kids (and sometimes, grandkids) succeed in life; for most parents, this includes providing financial assistance when it’s possible. In Canada, you can generally give of your wealth freely without immediate concern about gift or inheritance taxes, but there are a few caveats to keep in mind. Here are some possibilities and pitfalls to consider if you’re contemplating such familial generosity.
First and most important, before parting with any of your money or assets, you need to ensure that the action isn’t going to leave you short down the road. As most Canadians likely understand these days, we’re living longer than ever before, with the latest Statistics Canada data now indicating that the average life expectancy of someone aged 65 is around 20 more years (even more for women, but fewer for men). However, those are just the averages, meaning, some of us could well exceed that benchmark.
Therefore, the first order of business for anyone thinking about giving money or assets should be to examine his or her own financial prospects for what may be a long retirement. There is, of course, no way of predicting exactly what life will throw your way, especially over a period of 20 or more years, so it always pays to err on the side of caution.
Myriad factors can affect the equation, including your wealth status, age, health, expected longevity, and whether you have a spouse/common-law partner. The math can get complex and you definitely can’t afford to get it wrong, so it’s highly advisable that you seek professional help before making any commitments.
A qualified financial advisor can use specialized software to run multiple what-if scenarios and will be familiar with all the often-overlooked financial issues that can crop up.
In many cases, for example, we may need to consider the costs of institutional care in the latter stages of retirement. “The last 10 years of retirement often tend to be the most expensive,” says Nicco Bautista, the Vancouver-based director of estate planning at BMO Wealth Management.
You can’t automatically assume that any shortfalls can be anticipated simply by giving gifts in the form of demand loans that can be recovered if and when problems arise (with a demand loan, the borrower and the lender agree at the outset that repayment can be required at any time). Any repayment prospects would depend on the recipient’s own financial health and character, as well as the intended purpose of the money. If, for example, you provided the funds for the down payment on a house, it would be unrealistic to expect someone to immediately sell the home or take out a costly second mortgage to repay those funds, especially in the midst of raising his or her own family. “You have to be careful,” Bautista says. “It’s easy to give away money, but once given, it can be much harder to get it back.”
Only once you’ve ascertained your own and your partner’s long-term financial security should you contemplate giving away any of your wealth. “If you have the financial means, then it’s quite common to help the kids with a down payment on a house or to pay off their student loans,” says Nathan Bender, an estate and trust consultant at Scotia Wealth Management in Toronto. “But you do need to be cautious.”
Giving to minor children/grandchildren
As far as the taxation of gifts of cash or assets goes, Canada doesn’t impose gift or inheritance taxes. But if you give money or investments to children or grandchildren under the age of 18, the Income Tax Act includes attribution rules requiring that any income (interest or dividends) earned by these gifts be included on your tax return.
“These attribution rules are often referred to as the kiddie tax and they apply to any minor children, whether they’re related to you or not,” Bautista says. “There’s no such attribution once the kids are 18 or older,” he adds. And of course, there can be no attribution of earnings from inheritances, since the person to whom they otherwise would be attributed is no longer available, but then the question becomes one of whether the recipient is mature enough to manage that largesse properly.
There’s also no attribution of capital gains from gifts to minors, so you can minimize or possibly even eliminate the problem by giving assets—or ensuring that gifted money is invested in assets—that generate most or all of their returns through capital growth rather than income. That’s the case, for example, with certain types of corporate shares that pay no dividends, and with mutual funds and exchange-traded funds (ETFs) that generate a minimum of income.
“Most investment funds contain a split between bond-type assets that generate interest income and equities that generate capital gains, but some funds will be less income-focused than others,” Bautista says. “Some might be split 60/40 between those kinds of investments, for example, while others may be 10/90. If you’re planning to give to minor children, you should speak to your investment advisor about which funds or stocks would be most appropriate.”
If you do your own investing, it would be worth your while to investigate the investments in question to ensure that they meet the necessary income-versus-gain criteria beforehand. With mutual funds or ETFs, for example, you should read the offering memorandum or prospectus to determine the nature of the returns that a particular investment would generate.
Of course, if the money is intended to help a minor child purchase a new computer or some other electronic gadgetry that they really want, or if it’s to be used to attend special training courses or the like, there would be no concern about attribution because there would be no income stemming from the gift (even though it may help the recipient earn an income in future). If the intent is to provide funding for the child’s future educational costs, one alternative is a Registered Education Savings Plan (RESP).
“RESPs are one option for providing money to help a minor child or grandchild attend university,” Bender says. “There’s no attribution of income with an RESP, but there are limits to how much you can contribute to these plans. Subject to certain requirements, the government may also provide money through Canada Education Savings Grants and Canada Learning Bonds.”
The pros and cons of joint ownership
Many retirees contemplate joint-ownership arrangements for assets such as real estate and bank and other investment accounts, rather than leaving their assets to be distributed from their estate. Often this is done to avoid the provincial/territorial probate fees that would be applied to the property if it went into one’s estate. Sometimes, however, the primary purpose of joint-ownership arrangements can be simply to facilitate access to a bank account, for example, on behalf of a parent with mobility issues.
There can be further benefits to joint ownership. For one, assets placed into joint ownership pass to the surviving co-owner immediately, bypassing the estate and possibly reducing overall legal and land transfer fees (where applicable). “In the case of an inheritance, there would be legal fees involved in the transfer of a property from the deceased’s possession to the estate executor, and again when the property is transferred to the beneficiary, so the fees could be double what they would be in the case of a transfer into joint ownership,” Bautista notes.
But while joint ownership might indeed provide these economic benefits, there can nevertheless be perils in such arrangements. For one thing, the potential probate savings can be minimal, possibly even less than what it might cost to enact a joint-ownership arrangement, depending on the province in which you reside.
Manitoba, for example, no longer applies any probate fees, while in Alberta, the maximum probate fee levied on even a multimillion-dollar estate is $525. On the other hand, fees in Nova Scotia, Ontario, and British Columbia, based on a percentage of estate value, can amount to thousands of dollars on a sizable estate. You should first ascertain, therefore, how much you could save in probate fees when considering any joint-ownership arrangement.
In addition, you need to be aware that assets placed into joint ownership can become exposed to the child’s creditors or to matrimonial claims, in the event of a divorce. And unfettered access to an asset, whether a bank account or real estate, means the newly empowered child can essentially do as he or she wishes with those assets, including draining bank accounts, borrowing against a home’s equity, or even moving into the home with a bunch of unruly friends.
As a result, joint ownership should never be considered unless the relationship with the child is solid and his or her ethics are impeccable. “You need to be careful when using joint ownership, because the child could go rogue,” Bautista cautions.
If the purpose of joint ownership is simply to facilitate banking, and there’s any concern about roguish intent, Bautista suggests that arrangements be made in the form of powers of attorney (POA). “If a child is named as a power of attorney, then the money can be used only for the purposes of the parent,” he says. “There’s more scrutiny with a POA, whereas a joint owner isn’t accountable to anyone.”
Bautista cautions, too, that the documentation must clearly state that the ultimate intention is to transfer ownership, rather than simply to facilitate access. If this intention isn’t clearly spelled out, then at the time of your passing, the court will likely assume the intention was the latter and the asset will revert to your estate, defeating the original purpose.
“When people use standard bank documents for joint ownership, the purpose may be unclear,” Bautista says, adding that you should create a second document specifically stating that the purpose of the arrangement was to avoid probate and that the child is to be included on the deed as an owner of the property.
Special concerns with real estate gifts
When it comes to gifts or bequests of real estate, there may be additional tax considerations involved in a joint-ownership arrangement. If the property is your principal residence, any growth in its value while in your hands won’t be taxed, thanks to the principal residence exemption (PRE). So regardless of whether it’s put into joint ownership (in which case, an equal share of the property is deemed to have been sold), given outright as a gift, or bequeathed in your will, there are no immediate tax consequences.
If the child can continue to shelter the property from tax with his or her own principal residence, then there’s no ongoing tax liability, either. On the other hand, if he or she happens to own a home already and hopes to shelter that property with his or her own PRE, then making the child a joint owner or full owner effectively turns a tax-exempt property in your hands into a taxable property in the child’s hands. In this case, it would generally be advisable to put off any ownership transfer as long as possible.
Also worth noting: If there’s to be a change in ownership of a principal residence, then you must be sure to enclose a completed form T2091 (“Designation of a Property as a Principal Residence by an Individual”) with your income tax return for the year of the transaction in order to avoid a potentially nasty capital gains tax bill and possibly penalties.
If the property isn’t your principal residence, then the tax implications would depend primarily on the relative tax rates of the donor and the recipient. If, for example, you were in a high tax bracket and the child were in a low tax bracket, there might be an advantage to transferring the property sooner rather than later so that the lower tax rate would apply to any future capital gains. Conversely, if you are in a low tax bracket and the child is in a higher bracket, it may be advisable to put off the transfer. (This would also apply to income-generating assets such as company shares and mutual funds.)
Complications with multiple children
If you have just one child, then the calculations are relatively straightforward. If, however, you have more than one and, for example, want to make just one of them a co-owner of the house or of a bank or investment account, you have to be careful to ensure that this doesn’t result in an inequity in your treatment of the kids; otherwise, you could in turn create grievances or even legal challenges to your estate.
A similar consideration arises when it comes to beneficiary designations on assets such as RRIFs and life-insurance-policy proceeds. As with jointly owned property, these assets revert directly to the joint owner and bypass the estate, but if there’s a resulting tax liability—as with a RRIF, for example—then it’s the estate that must pay that bill. As a result, the RRIF beneficiary gets the full benefit, while other beneficiaries must shoulder the tax burden.
Even though there’s usually no tax liability associated with insurance proceeds, as with the previous two examples, giving to one child may create an imbalance—especially if that child receives, for example, a $100,000 tax-free bequest, while another receives the same cash amount but must pay the tax bill for the rest of the assets in the estate.
Of course, you’d be fully within your rights to give more to one child than to another, but there should be a reason for doing so. If, for example, one child has been diligently taking care of you while another has been off living the good life, such an action may be justified. However, simply including your reasons in your will may be insufficient, Bautista notes: “If one child feels that he or she has not been given a fair share of the estate, then in some jurisdictions—British Columbia and Ontario, for example—he or she can challenge the will in court. One solution might be a trust, which can help with litigation exposure.”
Bender comments, “There are a number of situations where you might want to create a trust rather than transfer money outright. It all comes down to protection and control, and it’s always best to get legal advice in this situation.”
The bottom line is that whenever you’re contemplating making a gift to a child or grandchild, you should consider your own needs before parting with any of your wealth. And when it comes to bequests to a child or children, these should be considered within the context of your overall estate-planning arrangements.