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PAYING FOR EDUCATION: Continued
INFORMAL IN-TRUST ACCOUNTS:
The most common vehicle used for investing money in a minor child’s name is an “informal in-trust” account. You can set up an informal in-trust account at your financial institution. It is sometimes simply called an informal trust. These accounts can be used to contribute money for the child’s use in the future, to achieve a degree of income splitting, or to invest funds that the child has legitimately accumulated (giving consideration to the Income Tax Act).
Currently, if a parent or grandparent wished to provide for a child’s education the assets are invested and placed in the name of the contributor “in-trust” for the child. This would not create a true formal trust but, for all intents and purposes, the monies belong to that child. Any income on the original capital would be taxed in the contributor’s hands and any capital gains would be taxed in the child’s hands. This taxation illustrates how the “in-trust” account can be used for income splitting. The amounts can be significant if the funds are generating primarily capital gains, which could be entirely tax-free to the child.
How does it work?
When you open the account, you name the child who will get the money. This child is your beneficiary. The account will be held in trust for them until they reach the legal age in your province. In Ontario, this means they won’t get the money until age 18.
What are the advantages?
- Fewer rules than Registered Education Savings Plans (RESPs).
- No special contract, in most cases. When you apply, you simply state on the application form that the account is in trust for your child.
- No minimum or maximum amounts to contribute. You decide how much, and how often, you want to contribute.
Who controls the money in the trust?
For investing, the account trustee will be in charge. This can be you, or you can choose someone else to manage the account for you. The trustee can choose from a wide range of investments, based on the laws in your province.
In many cases the financial institution will only take direction from you or the trustee, not your beneficiary. Even so, you can’t keep control forever. In Ontario, once the child turns 18, they can ask the court to turn the money over to them. Once the beneficiary has control, they can use the money in any way they like.
What taxes will I pay? What taxes will my child pay?
When your beneficiary takes money out of the trust, they will not owe tax on the money you have put in. That’s because you put in after-tax dollars, so you have already paid income tax on that money. There will be some yearly taxes on any investment income. But there are ways to reduce those taxes.
How can I keep the taxes as low as possible?
There are two different kinds of investment income from an informal trust account:
- Money you make investing your contributions. This money is called your first-generation investment income.
- Money you make by investing your first-generation investment income. This is called your second-generation investment income.
If you are not the trustee, your beneficiary can pay the taxes for you on any second-generation income each year. As a young person, their total income will likely be fairly low. As a result, the taxes will not be as much of a problem for them as they would be for you.
At F1RST CHO1CE Investment Solutions were passionate about sharing our knowledge, experience and unbiased opinions with families and individuals that are looking for a trusted advisor to help them with their Investment Planning options.
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