I was speaking to my good friend James last weekend about his son, who decided to make a trip to Las Vegas for his 19th birthday. As it turns out, his son is pretty good at Blackjack, and came back with double his money.
"Tim, I don't know whether to laugh and celebrate, or cry," James told me. "I'm glad my son didn't lose all his money, and proud of the fact that he's so good at Blackjack, but I'm not impressed that he took the entire savings in his in-trust account that we set up for him years ago."
I think this is cause for a look at in-trust accounts.
You'll know an in-trust account when you see one, by the name on the account. Most often, the account will be in the name of the adult "in-trust for" the child; for example: "John Doe in-trust for Bobby Doe." Many parents or grandparents will set up an account like this for a child because there's a desire to split income with the child. And for the most part, this can save tax. More on this in a minute.
Setting up an in-trust account can provide a vehicle for saving for an education, or for other purposes, and if the growth in the account over the course of time faces little or no tax, that growth can be much higher than if the parents were to keep the money invested in their own names.
There are some challenges with in-trust accounts. Three key issues, in fact. First, once your child has reached the age of majority there's no guarantee you can keep your child from taking the money in the account and running. There's a historic case called Saunders v. Vautier, which established that a trust can generally be wound up if the beneficiaries are of sound mind, have reached age of majority and want to wind up the trust.
As a practical matter, most parents assume their kids won't recognize their right to wind up the trust, and that a little moral suasion would likely prevent junior from blowing the money on a trip to Las Vegas even if he did recognize his rights. Ultimately, most parents would likely respect the rights of their children if the kids did choose to wind up the trust. Just be aware that this is a possibility.
Next, you won't be able to arbitrarily allocate the assets in the in-trust account to different children. If you've set up separate in-trust accounts for each child, you can't steal from one to give to the other. Even if you've named more than one child as beneficiaries on a particular in-trust account, you can't simply change the percentages allocated to each child. A formally established trust, with a written trust agreement, can provide greater flexibility here, but at a greater cost.
Finally, if you place assets into an in-trust account and name your spouse as the trustee (to avoid the attribution rules in our tax law – more on that below), what happens if your marriage breaks down? Your spouse will control the account. And if your spouse were to die, who would control the account after that? Perhaps his or her second spouse, or someone else named as executor over his or her estate. This may not be your intention.
As mentioned, an in-trust account can be used for income splitting. But you'll need to avoid the attribution rules in our tax law, which can cause all of the interest, dividends, rents or royalties to be taxed in the hands of the person who transferred the assets to the account. You can avoid this attribution by avoiding those types of income and focusing on capital growth. Capital gains will not be attributed back and can be taxed in the hands of your children named as beneficiaries on the account. Also, income earned on Canada Child Tax Benefits, Universal Child Care Benefits and second-generation income (that is, income on income), won't be attributed back to you.
Make sure that there's a true transfer of the assets to the child, the transfer is irrevocable, and you've specifically named the beneficiaries on the account. If you're the one who has transferred assets to the in-trust account, make sure a different adult (perhaps your spouse) is named as the trustee (that is, your spouse's name should be on the account, in-trust for the child). If you don't follow these guidelines, CRA could take the view that a trust doesn't truly exist, and that you should pay all the tax on the income earned in the account.
Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.