Investing on Behalf of my Kids

One of the most rewarding things about becoming financially knowledgeable and secure is being able to pass that knowledge on to your own children. When they begin to make, save and invest their own money, you will be there to guide them. If you want to take it a step further, you can start investing on behalf of your children as soon as they are born.

Many parents wonder how they can start saving for things like university, down payments on a home, or other big purchases their children will make later on down the line. The great news is there are a number of ways you can do so that will create generational wealth, including some tax-efficient investment options.

Let’s have a look at how you can begin investing for your child by opening an RRSP account, creating insurance accounts and trusts, utilizing TFSAs and more to begin saving for the big things in your child’s future.

Investing on Behalf of Children: RESP

At the end of the day, we want our future adult children to be self-sufficient with fulfilling work.  One of the best ways to give our children the best chance at achieving that goal is encouraging them to attend university and to earn a degree. This of course will make them more likely to earn more money throughout their lifetime, enabling them to invest and retire well just like you.

In Canada, an RESP is one of the best ways to help your child start saving for post-secondary education. It just so happens to be the most tax-efficient way to do so. You can easily open an RESP with our top recommended online brokerage, Qtrade.

If you are not familiar with RESPs, check out our full write up: Indexed Family Education Fund (RESP).

RESPs are great, but they come with limits. For example, there is a lifetime limit for each beneficiary of $50,000. Also, they are limited to spending the funds in their RESP on a qualified post-secondary institution. 

So, while it would be wonderful if we could know for sure that our child will pursue a post-secondary degree, there is no such guarantee. If your child chooses to pursue a different path, luckily, there are a few options of how you can use the money parked in their RESP.

If you do choose to go with an RESP and max it out, there are more options to help you invest for your children.

Life Insurance and Trusts

There are multiple companies out there offering tax-sheltered life insurance plans, such as Manulife and Canada Life, allowing you to save for your child’s future.

Essentially how these work is that you make a lump sum payment or annual payment of a certain amount to the life insurance company, and over time, interest accrues. These are tax-efficient because they are considered tax-exempt. Depending on the plan, you can later withdraw funds to help pay for your child’s education, graduation gift, wedding, and so on.

Another strategy is to create an informal in-trust investment account for each child, putting a lump sum in there, and indexing the portfolio to be used for a big future event. It is even possible for these investments to provide a small income stream for your child for life, if the portfolio grows large enough.

Say that I invested $10,000 into a balanced index portfolio returning 5% after inflation. When my kids are in their:

• late 20’s, the portfolio would be worth almost $26.5k in today’s dollars;
• late 30’s, the portfolio would be worth almost $43k in today’s dollars;
• late 40’s, the portfolio would be worth almost $70k in today’s dollars;
• late 50’s, the portfolio would be worth almost $114k in today’s dollars; and,
• late 60’s, the portfolio would be worth almost $187k in today’s dollars.

Formal trusts are needed for larger sums of money, and require a lawyer to complete the process. 

Both informal in-trust investment accounts and formal trusts are not tax-exempt, and you as the donor will be responsible for paying taxes on interest or dividends earned each year. However, the child will be responsible for paying the capital gains tax when they withdraw the money later.

Create an Investment Account Just for Your Kids

Another possibility is to simply open a separate brokerage account, knowing that the money in that account is solely for your child’s future. By law, minors cannot invest themselves until they are of age and have an earned income. That should not stop you from opening a separate brokerage account to fund their futures if you so choose.

Tax Consequences

There are tax consequences of investing on behalf of your children in a non-registered in-trust account. To get straight to the point, any dividends/interest generated by the account are taxed to the contributor (ie. parents would likely take the tax hit – not great).

However, capital gains are taxed in the hands of the beneficiary (ie. the children – bonus!).  With capital gains taxed in the hands of minors, this would result in very little tax in most situations.

In the case of RESPs and insurance, you’ll be better off in terms of tax liability.

The Ideal Investment Portfolio in Canada For Children

Having explained the tax consequences, if you decide to go the non-registered in-trust or ordinary non-registered brokerage account, here is a portfolio scenario for you. 

The ideal hands-off tax efficient portfolio would be a diversified indexed portfolio with minimal dividends/interest. While most index ETFs have distributions, there are some specialty swap-based index ETFs that pay no distributions, thus enabling the investor to pay capital gains tax only when selling.

These swap-based ETFs are Horizons Exchange Traded Fund products that:

• pay no distributions;
• have very low tracking error; and,
• very low MERs.

As of today, they cover:

• U.S equities via S&P500 (HXS) – MER: 0.07%
• Canadian equities via TSX60 (HXT) – MER: 0.10%
• Canadian bonds via CDN Select Universe Select Bond ETF (HBB) – MER:  0.15%

Unfortunately, they do not have an international equity product, but I suspect that they are working on one. As for asset allocation, due to the long investment time frame, I would personally keep the bond allocation to a minimum. 

Perhaps a split of 45% HXS/ 45% HXT/ 10% HBB. Here are some discount brokers that have preferred pricing on trading ETFs. If you would like to learn more about swap-based ETFs, check out more about them in our full write up on how to create A Super Tax Efficient Index ETF Portfolio for your Non-Registered Account.

Final Thoughts

As with investing for ourselves, the benefits of investing for your child are multiplied many times when you start early. Tucking a little away each year while your little one grows is a great way to ensure they have more time to enjoy those big life moments without the worry of finances.

It doesn’t mean you’ll want your child to feel like they were born with a silver spoon in their mouths. Even Warren Buffet has said he’ll give his children,

“…enough money so that they would feel they could do anything, but not so much that they do nothing.”

Education is one of the biggest gifts we can give our children, especially financial education. Once they begin earning money themselves, you’ll be able to guide them in opening their first brokerage account and to start investing, giving them a strong start on their own million dollar journey.

What are your thoughts on starting an investment account for children?