An informal in-trust for account is not a widely known type of account.
Hear the word “trust” and one might immediately think it sounds complicated and is expensive — it isn’t. An informal in-trust for (ITF) account is simply a type of account managed by a person of age (at or above the age of majority), for the benefit of another person (normally a minor).
In contrast, a formal trust account, is held by a trust which is governed by a trust deed. A formal trust generally has three parties to it — the contributor, trustee, and beneficiary — and clearly defined powers governed by the agreement.
To help with understanding how an informal ITF account is set up, we will look at the parties involved in opening the account.
Firstly, there is the person who is putting funds into the account, whom we will refer to as the contributor. In the majority of cases for our clients, this is either a parent or grandparent.
The beneficiary is generally irrevocable and is the person who the account is ultimately getting set up for (typically a child or grandchild).
Finally, there is the trustee, who is the person who will oversee the investment account and be responsible for the tax reporting component. Because of new trust reporting requirements; there is a possibility that an informal trust may have tax filing requirements.
When we open these accounts, the only document created is the investment account opening document. The name of the individual beneficiary is listed within the investment account opening document. The trustee’s social insurance number is used on the account opening form. The trustee ultimately is responsible for determining that the investment income is allocated to the correct taxpayer.
The tax implications of an ITF account is an area that should be discussed. CRA may attribute all investment income to the contributor for tax purposes, and disallow income splitting between the contributor and related beneficiary because they’re not acting at arm’s length. Related beneficiaries include children, grandchildren, nieces, nephews, and others related to the contributor.
Under section 75 (2) of the Canadian Income Tax Act (ITA) income includes interest, dividends, foreign dividends and capital gains. Nieces and nephews are considered related for income tax purposes only for income attribution rules in section 74.1. It is important to note that section 74.1 (2) of the Canadian Income Tax Act (ITA) does not attribute capital gains related to minors. We will talk more about investment approaches below regarding capital gains.
CRA does provide some exceptions to the above, including if the ITF account contributions are provided from the Canada Child Benefit (CCB) payments, and inheritance. In these cases, all income, including interest, dividends, foreign dividends, and capital gains may generally be attributed to the beneficiary.
If the beneficiary had their own earned income and contributed those amounts into an ITF account, then this would also be another exception. It is important to note that these exceptions should not be commingled with property from the contributor which may be subject to attribution rules.
Even though an ITF account is not governed by a formal trust agreement, they are still legal and are considered a valid trust. By contributing funds to an ITF account, they should be treated as irrevocable, and account withdrawals must be used for the child’s benefit until the age of majority is reached. There are adverse tax and legal consequences that could result if the funds were not distributed to the intended beneficiary.
When these accounts are set up, we encourage our clients who have set up the account to name an alternate or replacement trustee. Without doing this, and if the trustee passed away, the account would typically have to be held in the estate’s name until the beneficiary reaches the age of majority. If the minor beneficiary passes away, then the ITF account would be distributed according to the rules of the jurisdiction.
Educational component
When we meet with families that want to have financially literate children, we will discuss opening an ITF account. Spending time to talk about the different options for investing and the different types of investment income can help them gain knowledge that is largely omitted from the school curriculum.
Teaching children how to save
The first step before investing is learning how to save. We have had clients keep track of the money their child has received from gifts, allowances, small jobs, etc. They can put that money either into the bank or into an ITF account. Teaching your children how to save, and what to do with the savings, can assist them in learning how to build up equity.
Wider investment options
Minor children in British Columbia are restricted primarily to bank savings accounts. If savings are at $500 or higher, a minor child can purchase a Guaranteed Investment Certificate (GIC).
In order to invest outside of these two areas, a minor child would need the assistance of a parent or guardian. In these situations, an ITF account is set up where the parent or guardian sets up the account in trust for the minor child.
The account is managed by the parent; however, this opens the investment options considerably.The parent can open a regular brokerage account and purchase various other types of investments, for example, stocks, bonds, mutual funds, and exchange traded funds.
Small inheritances
When minor children receive small inheritances (under $100,000) we may open an ITF account depending on the age of the child. This may have come from a grandparent or other family member. If a parent or relative is available to be the trustee, and it is consistent with the will, an ITF can be used. The younger the child is the greater the time horizon and investing the funds may be more suitable than keeping in cash.
Helping a child purchase a home
One of the biggest concerns many of our clients have is how to assist their children in purchasing their first home. There are various programs that are available to our clients’ children once they reach the age of 19, such as the First Home Savings Account (FHSA), Registered Retirement Savings Plan (RRSP) Home Buyers Plan, and Tax Free Savings Account (TFSA).
What can be done before the age of 19 in British Columbia? Parents with children under the age of 19 can look at opening an ITF account. Regular savings within this type of account can create a decent sized nest egg over time that can assist with a first-time home purchase.
It is easier to do this over time rather than all at once. At age 19, amounts from the ITF accounts can then be transferred into the beneficiary’s other types of savings’ vehicles noted above (FHSA, RRSP, and TFSA) or into a non-registered account. To avoid any confusion around taxation of the investments we typically recommend a strategy that generates capital gains only.
Helping with education costs
Sometimes a minor child has a parent that is contributing the annual maximum to a Registered Education Savings Plan to obtain the Canada Education Savings Grant. Other relatives, such as grandparents, may also want to assist with helping out the grandchild. In these cases, we will set up an ITF account for the child.
These funds are essentially gifts to the grandchild. To avoid any confusion around taxation of the investments we typically recommend a strategy that generates capital gains only.
Attribution and capital gains
CRA may attribute all investment income to the contributor for tax purposes, and disallow income splitting between the contributor and related beneficiary because they’re not acting at arm’s length.
Essentially the income generated within the ITF account is taxed in the adult’s hands that opened the ITF account. The exceptions to this attribution rule, are if the amounts deposited are from CCB payments, inheritance, or the beneficiary’s own earned income, then the income within the ITF account is taxed in the hands of the beneficiary (the minor child).
Outside of the above exceptions, when property is transferred to a related minor, section 74.1(2) of the Canadian Income Tax Act of the Canadian outlines that there is no attribution on capital gains or losses.
Investment selection
If none of the exceptions apply then the contributor may deposit funds into the ITF and invest the funds in a way that it does not generate interest income, foreign income, or dividends.
It is possible to purchase an investment that will generate only capital gains. In cases where a parent or grandparent is contributing to an ITF account, we will recommend a growth equity with no dividend.
One of our favourite ITF ideas is to invest only in Berkshire Hathaway Inc. class B shares. Berkshire Hathaway does not pay a dividend, which makes it an ideal candidate. We also feel that parents can talk about Warren Buffet, and show children a few videos and books — an ideal financial literacy moment.
We recommend that our clients hold these shares until the minor reaches the age of 19. Additional deposits can be used to purchase additional Berkshire Hathaway shares whenever additional funds are put into the ITF account.
Rules relating to trust accounts have been changing in recent years. It is important that you speak with your legal and tax advisors regarding your current situation.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email greenard.group@scotiawealth.com, or visit greenardgroup.com.
