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.
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.
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?
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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.
where can you open an intrust account? which bank is the best to do this at?
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?
FT: can you borrow to fund an informal trust for the kids? If yes, is the interest tax deductible?
That is a good question, I’ll need to look into that one!
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.
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?
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.
So the question is really, do you need coverage in case one of the kids pass away? The more likely scenario is if the kids live a long time, by that point, you are really giving the benefit to your childs spouse/your grand children. And when your advisor says that they’ll have $1M for retirement, that isn’t entirely accurate. There will be a balance in the policy but your child will only be able to BORROW against that amount rather than simply withdraw from it. It can basically be collateral for a bank loan.
If it was me, I would invest in their education (RESP) first. If you’ve already done that, I think that an in-trust investment account depositing $1500/year for 20 years would be a better bet.
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!
Arlene, I would generally avoid whole life insurance policies for children – unless they have a condition that may impact insurability in the future. In my mind, insurance is financial protection against a worst case scenario. With your children not generating any income, does it make sense to insure them? Personally, I would avoid.
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…
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.
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.
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!