Investing on Behalf of my Kids

Ever since the kids were born, I often think about their financial futures.  I wonder what they will do for a living when they get older, and whether they can build wealth rather than succumbing to the heavily promoted North American consumer lifestyle.  I can now see why my parents often tried to nudge me towards medical school as physician jobs are plentiful with well above average salaries.

On the other side of the coin,  simply having a high paying job sometimes just isn’t good enough. I’m a believer in following your interests as I believe that life is too short to be unhappy with your work on a daily basis.  My wife graduated with a professional degree in a health care field that offered a relatively high salary.

It was all well at the beginning, but it became less appealing once the kids were born.  As her career interest faded, it eventually impacted her overall happiness.  So together we made the big decision to leave her professional career behind and figure out how to make it work financially on one government salary.

Investing on Behalf of Children

At the end of the day, I want my future adult children to be self sufficient with full filling work.  On the way to becoming self sufficient, I believe in post-secondary education.  Which is why we have committed to maximizing our family RESP (what is an RESP?) on an annual basis to help pay for their undergraduate degrees.

But what about the scenario where RESPs are maxed out and you want to do more?  One strategy that I’m contemplating is opening an informal in-trust investment account for each of the kids, putting a lump sum in there, and indexing the portfolio to be used for a big future event.  For example, the down payment on their first home, their wedding, or maybe a trip to see the world.  Or perhaps if the portfolio grows large enough, it can provide a small stream of income for life.

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

Tax Consequences

Of course, 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. in my case, I would 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.

The Ideal Portfolio

Having explained the tax consequences, 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 he 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.

Final Thoughts

I heard a Warren Buffett quote one time that summarized his thoughts on leaving a lot of money to his children that resonated with me.

To Mr. Buffett, the perfect amount of money to leave children is:

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

Having said that, I don’t believe there’s any harm with helping young adult children with many of the big financial milestones that occur early in life.  Perhaps starting a tax efficient indexed portfolio now could help offset some of those big upcoming expenses.

Now what we do with our growing early-retirement portfolio when we pass away is a topic for another discussion.

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

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Colleen
1 month ago

My 14 year old son has been asking if he can buy stocks. Where can I open up a brokerage account for him? I’ve been reading about in-trust accounts for kids, but don’t know where to get one for him. Thanks.

Matt
2 months ago

where can you open an intrust account? which bank is the best to do this at?

Paul
4 months ago

Is there a way to open up kids investment account, where I can buy and hold ETF’s so the T5/T3 is issue under my kids name? Which discount broker?

Ahmed
2 years ago

FT: can you borrow to fund an informal trust for the kids? If yes, is the interest tax deductible?

Dividend Earner
4 years ago

@Arlene

My parents took whole life insurance on my kids for $50K each paid over 10 years. It was a way for them to help us and the reality is that while they don’t have income to protect, a funeral cost money with all the arrangements needed. So it was a way to potentially help us and it’s money the kids could access in the future.

I would have preferred that they contribute to the RESP account or create an account in trust based on what I know now.

Arlene
4 years ago

Thank you two for taking time to respond. I think the financial planner is trying to look at this as it will be beneficial if something does happen to the kids unexpectedly (their passing) and to have the insurance there for expenses but also she is thinking it may be useful for them for the future. We will be paying $1500/yr per child for twenty years. After that we no longer have to pay into the policy and the policy itself keeps growing and compounding. If they don’t touch it all their life and they go to retire they will each have around one million dollars to use. I just dont know if these whole life insurance policies are legit or if they should be avoided?

Dividend Earner
4 years ago
Reply to  Arlene

The growth of money is always great to hear and it’s a great sale techniques but ask yourself how it would perform if you were to just buy an index fund with that money.

The $1,500 per year that you put aside for them can do the same thing while you retain control of the money.

As mentioned, I would have preferred something different like an investment. Look into computershare and invest the money in trust.

Arlene
4 years ago

Hello! I was wondering what your thoughts were on The equitable Life Insurance Company of Canada. A financial planner thinks it’s a good idea to get whole life insurance policies for our three children, each $100,000 policies. Is this a good idea? I know this doesn’t necessary pertain to their education future however it is still in regards to their future and I’m really struggling to know if this is a good path to take. I am definitely not a financial expert like some of you in here, I’m a stay at home mom trying to make the right decisions for my kids. Any insight would be appreciated!

Patrick
4 years ago

I opened a seperate TFSA in my name for my daughter. She helps me with a weekly cleaning job, and I pay her, but take half of it and put it into the TFSA. I told her to pretend I am the tax man, so she will be used to not getting the full amount she earns when she has a real job.
I buy dividend paying stocks for her, so one day she will be able to see the value of investing compared to laboring for money.
It would be nice if she was able to open her own account, but I guess she will just have to trust me that I will pay her out one day…

Richard
4 years ago

Sometimes I wonder about how much it really helps to give large gifts. If they use it to get a bigger house or a newer car is it helping them? If they can’t afford it without the gift is it a good choice?

I would think that something that has a clear long-term benefit like education is a bit different. Aside from that I’d like to come up with ways to help make things easier (and avoid major disasters) without taking away their independence.

A really interesting idea I heard was to give some bonus every month that’s proportional to their working income so they have more reason to work for it. Helping to invest or even giving a high interest rate would also encourage good habits. Another option might be to let them choose between receiving an income from the portfolio (say 5 – 10% per year) or letting it grow, so it’s enough to help but not enough to live on.

But at some point if they are independent they will need to make larger decisions. If you’re going to give it all to them eventually this could be done in larger steps as time goes on.

aB
4 years ago

We invested all our kids’ birthday/NewYears money, but left slips of paper with the dollar amount (and date received) in the envelopes/red packets. They exist in my Wife’s TFSA. XIC for my son, VCN for my daughter. (Screenshots of every purchase.)

Hope is when they are .. ~12 (?) they start asking about the money. Give them the envelopes let them add it all up. Then show them the value of their account. Make it a teachable moment.

Alpha Centauri
4 years ago

Some great comments here! Most importantly, teach your kids about money and finance from a young age. I think that is more valuable than leaving them a large trust fund. That Warren Buffett quote is spot on. He rightly knows that a large windfall to his kids will ruin them. I really admire Warren Buffett. He manages a multi-billion dollar business, but I think he still lives in the same modest house he bought in the 1950s!

We have a young toddler now, but I plan to have regular discussions with him about money and finance in the future. Even something simple like showing your kids this website and discussing its content, can be a useful learning tool!