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.
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.
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?