Posts from the ‘Financial Planning’ Category

Dec 11

Taking Note of the Possibilities: Auto-Callable Contingent Income Notes

I have a confession to make – I’m fussy about surprises. I’d much rather save them for birthdays and major holidays than when reviewing my investments. Admittedly, volatility can sometimes be an investor’s best friend, such as when that a penny stock is suddenly worth dollars, these happy surprises are outweighed by the times things go the other way, which leaves me feeling like I’ve just found out that Christmas was cancelled while sitting on a piece of birthday cake. And, for investors who are on track for a comfortable retirement, are tired of getting motion sickness when tracking the ups and downs of their stock portfolio or are already in retirement and can’t afford to get it wrong, you should feel the same way.

I’ve previously written about how volatility when you have your good vs. bad investment years (your “sequence of returns”) can have a profound effect on the eventual size of your portfolio, particularly during retirement when you might have to “sell low” to pay for golf and groceries. On the other hand, I’ve not written nearly enough about some of the other risks investors have when saving for retirement, such as running out of money due to not taking enough investment risk: GIC investors, this might mean you! If your money needs to last you through 30 plus years of retirement, settling for investment returns that might not even keep up with inflation after including taxes potentially means tough times if you live into your 90’s (or 100’s if some of those alleged medical advances actually pay out) unless you’ve got other assets that pick up the slack or have either have or will later inherit a healthy nest egg.

Structured Notes – What Are They?

Although I love the regular income that GICs can produce and appreciate the peace of mind that comes with the typically complete capital protection, I’m willing to take a bit more risk to hopefully reap a lot more reward. Although there is no silver bullet perfect for every occasion and every market, I’ve found a few tools that can produce a significantly higher income without dramatically increasing the risk of getting birthday cake on my snazzy new pants. In other words, while I’m taking on more investment risk than a GIC, I’m also giving my portfolio a chance to at least keep up with inflation to combat longevity risk, — otherwise known as the possibility of having to survive entirely on bologna sandwiches later in life. Today’s offering talks about one of these tools designed to thread the needle between investments that are too unpredictable and those that too stingy: auto-callable contingent income notes, a subclass of a class of investments known as structured notes.

In general, structured notes are investment products created by banks that track the performance of underlying investments and pay investors according to how that particular underlying basket of investments performs. The banks issue a bunch of different notes with different potential returns based on different underlying investments, ranging from the performance of the entire TSX, a basket of a few stocks, such as the big 5 banks, or even the performance of a single stock, such as Tesla.

In many ways, structured notes are like betting on sports, although with typically far less risk than overzealous Leaf fans may have experienced over the years. The banks offer an ever-changing array of notes, each with different potential outcomes and levels of risk, depending on current market conditions. Investors investigate the different notes and place their bets based on their assessment of risk and return. Like any good bookie, the banks cover their risk by purchasing options or zero-coupon bonds in the investment market that match the terms of the notes on offer so they are not out of pocket if the investors win. In fact, both the banks and the investors have something to celebrate if this happens– since someone else will ultimately be financing the investors’ profits, the bankers are still smiling because they got to use the investors’ money along the way, minus the cost purchasing the protection, to do bank-like things, like lending it to other clients or investing it for their own profit.

Although there are a wide variety of notes on the market, I just want to talk about one type– auto-callable contingent income notes, a name obviously not chosen by an advertising professional. This product provides a regular income stream provided that the underlying investments doesn’t drop below a predetermined limit. It is typically considered a hybrid of both stocks and bonds – the returns are based on the performance of stock, but investors don’t participate in the growth of the underlying investments (although there are other structured notes that offer this feature if you’re so inclined.) Instead, investors get a constant payout for each specified period (such as monthly, quarterly or annually), much like a bond unless the underlying investment has dropped more than a preset amount as of a specific day. Also, unlike stocks, any proceeds from notes are almost always taxed as interest.

The Value Proposition and an Example

The best way of truly describing this class of notes is by way of example. Although I’ll recklessly throw some investment jargon your way, keep reading and hopefully all will soon become clear. A typical note issued in today’s high interest and uncertain times might offer 12% annual income paid monthly (each payment is called a “coupon”) based on the underlying performance of a basket of Canadian banks with a 30% barrier and a 30% partial maturity guarantee when the note matures in 7 years (although 5- and 3-year maximum lifespans are also common) with a 110% autocall feature. Translating into English, this means that so long as your basket of bank stocks hasn’t declined in value more than 30% from the date the note was issued on a preset day each month, you earn that month’s interest coupon. If, instead, financial Armageddon hits and your basket of banks is down 35% on the day in question, you miss that month’s payment. The next month, however, if the banks have rebounded even slightly to 71% of their original price, you earn that month’s income, although last month’s lost interest remains lost and gone forever most of the time.

This monthly calculation continues until one of 2 things happen – either the underlying basket appreciates by more than 10% of its original value (the “autocall” price) or 7 years have passed and the note “matures.” In the first scenario, investors get their final interest payment, plus all of their original investment back as of the month the basket hits its target growth rate. In the second situation, it all depends on the value of the basket at the time of maturity, plus the amount and type of downside protection purchased. In the example I’ve given, which is a 30% “barrier,” at maturity, if the basket is worth at least 71% of the original value at that time, then the investor gets a full refund of the original purchase price and their final interest payment. On the other hand, if the investment is only 69% of the original value, then they would only receive $69 of the original note. Put another way, this investor gets all their money back so long as the underlying bank bundle hasn’t declined by more than 30%, but, if it has, they are on the hook for the entire loss.

If the latter outcome is too risky for your blood, you might purchase a note with a “buffer” instead. While a barrier provides protection if the loss is within a certain range, buffer notes offer protection even if the loss exceeds the preset threshold. Using my previous example, if you owned a 30% buffer instead of a 30% barrier and the basket was worth $69 at maturity, you’d still get back almost all of your original investment, although your monthly interest payments would likely have been less than those offered through a barrier note. As you’d expect, you pay for this extra protection by accepting a lower yield since the bank has to buy more expensive protection to cover the potential loss.

Other ways to Protect Yourself

Although buying a buffer dramatically reduces downside risk, that is not the only way of increasing your odds of a positive outcome. Here are some other tactics to increase the chances of a happy ending:

Increasing the size of the buffer or barrier. Is 30% not enough protection to protect the quality of your nightly slumber? Consider buying 40% downside protection instead, both to protect your regular income and how much you’ll get back if the note isn’t redeemed until maturity.

Purchase notes with a memory feature. Although being under water on the observation date typically means losing that period’s payment forever, notes with a memory feature allow you to play catchup. Once the note is once more above its barrier or buffer on a future observation date, the investor gets both their regular payment plus any payments they may have missed in the past.

Buy notes that go low. There are occasionally notes that calculate the initial value of the note for future observation date purposes based on lowest value of the underlying bundle within the first observation period. For example, a note with a semi-annual coupon based on the TSX with a 30% barrier with this additional feature would pay that half-year’s coupon so long as the value on each observation date was at least 70% of the value of the TSX at its low point during the first 6 months after the note was issued rather than the bundle’s original value at the time the note was issued.

Opt for monthly coupons. If there is a precipitous decline in the value of the underlying investment on an observation date, it’s far better if you only miss one month’s coupon payment instead of perhaps an entire year’s worth. Different notes offer different payout periods, such as monthly, quarterly, semi-annually or yearly. Since a really bad day in the market on the observation date means not getting paid, picking the monthly coupon option means only missing one month’s worth of income if the investment world is far less dire a month later. Although picking shorter payment periods can cost you the occasional payment if the bundle is underwater for a month or two but rights itself by the end of the quarter or year, I’d much rather accept this risk than chance risking an entire year’s worth of income by selecting a note with longer gaps between payments.

Picking a boring bundle. Hedge your bets by picking a note based on an underlying investment you think is conservative or which you view as already significantly discounted. As an added bonus, because of this recent volatility, notes based on investments with a recent decline generally offer higher coupon payments. Some clients recently purchased notes based on Canadian banks for these reasons, for example. It is even possible to purchase a note based on an entire index like the TSX rather than a specific sector to if you feel that this is a safer bet.

Pushing out the lifespan of the note. The duration of the structured notes can also vary. One school of thought suggests that the further out in time before a note matures, the smaller the chance that the underlying basket will be less than the protection purchased at that time. If you believe that the market ultimately wins in the end, increasing the distance between purchase and the maturity date plays into this philosophy. Moreover, since notes can also be sold on the secondary market, notes with a longer maturity period aren’t as volatile if you need / want to cut bait and sell along the way.

Selecting the autocall carefully. Most notes do not make it to maturity. In fact, the majority are redeemed within a couple years of issue. Sometimes this is a good thing and sometimes, not so much. If you love the interest rate and the underlying basket, look for a higher autocall threshold such as 110% of the original bundle value vs. 105% so you can keep raking in the cash for a bit longer. On the other hand, perhaps you just want to park your money in a note until you feel better about the market and / or don’t love current note rates. If you have an autocall feature where you’re redeemed when the investment climbs by only 5% vs. 10%, you will be bought out potentially far sooner if the investment performs, at which time you can redeploy your capital into either another type of investment or perhaps another note with more favourable terms.

Purchase a note with the right initial observation date. Even if you have a monthly autocall feature, your note will have a minimum initial waiting period before the autocall feature kicks in. If you love your current note, picking perhaps a 1-year initial observation date vs. 6 months may help keep the good times rolling that much longer.

Buy a bundle of bundles. Rather than just purchasing a single note based on a single bundle, spread out your risk by purchasing several different notes based on different underlying investments. In fact, structured note ETFs have recently come onto the market in Canada. Although the one I investigated is too new and has only 20% barrier protection, who knows what will be on offer in a couple years or how existing products have performed.

Pick a note that matches your ultimate time horizon. Although most autocall notes are redeemed within a couple of years and there is a secondary market should you wish to sell, consider matching the ultimate duration of your notes to when you need the money. For example, if investing in a TFSA to purchase a home in 5 years, a note with a 7-year maturity period might not be the one for you. As stated earlier, however, if you really need the cash, there is a way out. In fact, structured notes may be cheaper to unload in some situations than non-cashable GICs, depending on how your note is priced in the secondary market.

Don’t be a one trick pony. No matter how much you like this type of investment, continue to diversify your portfolio with different types of investments. For GIC fans, this might mean combining structured notes with a few GICs as well in order to further reduce your risk. Ditto for those investors who are big on bonds, preferred shares or perhaps other investments like Mortgage Investment Funds, which I see as the main competitors, although each has their own pros and cons.

More Note Planning Tips

In no particular order, here are some more tips to consider when looking into purchasing notes:

Shop around. Not all banks offer the same rates at the same time. If your broker is linked with one of the big banks, make sure that (s)he also looks at what the competitors are selling.

Realize that notes pay interest and plan accordingly. Although notes are based on an underlying bundle of stocks, all distributions are taxed as interest income. Accordingly, they are best owned in registered plans, family trusts with low-income beneficiaries or by low-income individuals not worried about things like the GIS clawback.

Focus on the big picture when assessing risk. When choosing between this type of product vs. alternatives like GICs, preferred shares and bonds, consider the risk of a note being redeemed for less than full value at maturity but also the extra income you may have received along the way vs. some of these alternatives. It could be that the extra cash received before then from a higher yield, particularly if you have buffer protection that absorbs most of the loss, still leaves you better off than something like a GIC with 100% principal protection but a much lower yield. Do a similar analysis if deciding how to allocate money among investments like notes, bonds and preferred shares, although you’ll also have to factor in the chance of those other options producing capital gains or losses (although this could also arise if trading structured notes on the secondary market.)

Get your broker to custom-fit a note. Like a good bookie, banks are typically willing to create tailor-made notes for the right client if worth their while ($1 million seems to be the minimum note size.) Accordingly, if you can’t find the exact note of your dreams, see if your broker or portfolio manager is willing to work with a bank to create a custom fit. It’s not like you’d have to purchase the whole thing – my own portfolio manager is currently working to create one that a bunch of his clients will share, plus whatever other investors may snap up.

Performance Notes

The following stats, plus many useful tweaks and suggestions, were provided to me by two Portfolio Manager friends at Aligned Capital – Thomas Tsiaras and Wail Wong. A big thank you to both of them for their expert advice.

The following chart pertains to National Bank products from 2016-2022. Our notes of choice, auto-callable contingent income notes, are included as part of the “Non-Principal Protected Notes” family, as opposed to the “Principal Protected Notes.” The first category covers notes that include only partial protection (an average of 32.7% downside coverage) while the second cluster fully guarantees that investors will not lose money.

While the fully protected notes, including market-linked GICs (which are not be confused with your guardian variety fixed income GICs) did ensure that no one lost money, they only produced an average annual return of 3.3%. In contrast, notes with partial protection averaged an annual return of 8% even after factoring in losses. Moreover, the partially protected notes failed to make a profit only 2% of the time, versus 24% for notes with full coverage. In other words, in exchange for taking on this extra risk, which only resulted in neutral or negative outcomes 2% of the time, the investors earned more than twice as much than their more conservative friends, with a higher chance of making money.

Fee Classes

Notes are either sold as “A” or “F” class, just like many other types of investments, either with an embedded commission for the advisor (A Class) or with that commission stripped out, with advisors charging their clients an advisory fee directly (F Class.) As you would expect, F class notes offer a higher yield.

Some advisors may offer clients the choice of purchasing either class of notes – those with a one-time fee embedded into the product but with a yield that is adjusted to cover these costs or those with the commission stripped out but with ongoing advisory fees paid directly, although this will likely require clients who purchase both versions from the same advisor to hold them in different accounts, one managed by the advisor and the other self-directed. In some cases, choosing the Class A notes can even be a win-win for both client and advisor – the lower A class yield may be less than what the advisor charges management fees, but the advisor still makes a healthy one-time commission, particularly if the note is sold or autocalled within a couple years and the clients reinvest the proceeds with that advisor.

Conclusion

Although they have been around for a while, auto-callable contingent income notes are currently one of the trendiest investment options for clients looking for higher yield with some extra protection. Although they may have more moving parts than a caper movie, don’t let that scare you off from putting in the work to see if they have a place in your own investment portfolio. The retirement you save might just be your own.

Apr 13

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Playing With House Money #2 – Gifting, Loaning or Co-owning?

In my last article, I discussed many of the different ways that Canadians hankering to eventually own their own home could best save towards funding this dream. Today’s offering discusses the three most common options available for parents when the youngster wants to buy a home but needs a little more help to get them across the finish line when it’s time to purchase:

Gifting;
Loaning; and
Co-owning.

And, although the article discusses parents helping children, I’ve only done this to make this article easier to write- the options discussed apply to anyone looking to help a family member or even a really, really, really good friend get a place to call their own.

Overview

Before going advancing any money, I strongly suggest first taking a step back and having a heart-to-heart conversation with yourself. Some of the questions you may pose are:

How will helping impact your own financial future? How much could you safely loan or gift without risking a future full of Kraft Dinner during your so-called Golden Years?

Are junior’s financial forecasts realistic ones? And, are you prepared and able to commit more money in the future if (s)he has bitten off more than (s)he can financially chew? In some cases, you all may ultimately be better off if junior scales down their dreams so that (s)he can have both a comfortable home and a comfortable lifestyle.

How secure is the child’s relationship? Not only will this affect whether or not now is the time to advance some funds, but the form this assistance might take.

Is struggle good for the soul? And, is it possible to be too generous? Will this particular child benefit from having to save a little longer, scale down expectations or struggle with the responsibility of living on a tight budget? Or, does this parsimonious approach merely make life needless harder while simultaneously depriving you of the benefit of watching the next generation enjoy the fruits of your generosity? Feel free to insert any additional existential questions of your own.

Meet Your Options

Should you still wish to help after wading through this swamp of difficult questions, the next issue is what form of assistance is best. Here are the leading contenders:

Gifting – Simple but Risky

Assuming that you will never need the money back, this option is the simplest and often works out just fine. All the same, allow me to don my legal robes and point out some of the things that can go wrong, sprinkled with a few suggestions about how to limit your risk:

If your child is successfully sued, your gift is up for grabs.
If junior is financially irresponsible or faces problems like gambling addiction, you don’t have the same financial clout as someone who is a lender or co-owner.
There is no guarantee you’ll ever get the money back if you later discover that your child is married to Bernie Madoff’s evil(er) twin. It is often better to give (or loan) a little less than to risk running short of cash yourself when a super senior. You can always give more later once your own financial future is more certain or when your kid demonstrates that they are not a complete financial train wreck.
Although most provinces protect the amount of a gift in the event your child divorces, (s)he will still have to divide any growth in the place’s value 50/50. And, in provinces like Ontario, gifts used to purchase the family home are ignored when divvying up the matrimonial pie. In other words, if a marriage based in Barrie doesn’t work out, half of your generosity will end up in the hands of someone your child may now cross the street to avoid. Is this a risk worth taking?
If your child dies first, you have no control what happens to your gift. While most parents wouldn’t mind so much if the gift passed to their grandchildren, you might feel decidedly differently about a $200,000 gift passing to a son/daughter-in-law you can’t stand or some random charity a single child might name in their Will, particularly if you have other children that you’re rather received the funds.
If planning to gift to other children in the future, do you need to include language in your Will to equalize things at that time if you don’t get the chance to do so during your lifetime?

If gifting still sounds like the best option, I suggest actually going the extra mile and documenting your generosity in writing in order to avoid potential legal problems later. If your intentions are unclear, the law assumes that any funds paid to adult children are loans, rather than gifts. Accordingly, if your kids don’t get along, or your new wife isn’t the biggest fan of your old kids, your gift to those children may be unintentionally clawed back when you’re 6 feet under. Lawyers prepare something called “a deed of gift” that puts this issue to bed. Not only can these documents ensure that your child gets to keep the gift, they can also hopefully avoid hard feelings over Christmas dinners after your ashes have been scattered over your favourite golf course if other family members had a different understanding of your intentions even if they don’t involve lawyers.

And, if you are planning to help other children in the future, consider whether you want those children you didn’t get a chance to help during your lifetime get a bigger share of your estate later. If the answer is yes, also consider whether you need to bump up the value of any post-death equalization payments in your Will to take into account things like inflation and what planners calls the “time value of money.” Put another way, a gift of $100,000 5 years ago is worth a lot more than a similar gift made today – do you need to adjust any equalization payments to take this into account?

Loans – Help with Strings Attached

9 out 10 lawyers prefer lending over gifting 95.2% of the time when the size of any cash advance is at least 6 digits long. It’s not always because of the things we can anticipate going wrong, but because of the things we don’t. Knowing that we can’t predict everything that might go awry, we like to keep our options open just in case. Unlike gifts, loans can be called in if parents do need the money back, the child gets sued, has a failed marriage, likes to bet on the ponies a little too much or (insert reason of your own.) It’s not like you need to charge interest and it’s always possible to forgive the loan at a later date, such as in your Will – it’s simply about adding a little extra protection and flexibility to our clients’ planning.

If you’re pretty sure you might need the money back or are actually having to borrow yourself to help the child get that housing toehold, a loan becomes an even better idea. In such cases, perhaps you do charge the child interest equal to your own borrowing costs, such as if you’re using your own HELOC to come up with enough money to get the child into a bungalow. I’ve even heard of some parents taking out a reverse mortgage to help the child get started, although I worry about what happens if mom and dad ever need to go into assisted living and most of the equity in their place has essentially been transferred into junior’s abode.

If going the loan route, here are few options, recommendations and consideration to chew on:

Review the law regarding division of property in the event of a divorce. Many provinces protect the sum originally gifted to a child if (s)he divorces, even if any increase in the home’s value is still split 50/50. On the other hand, this is not a universal law and if you live in Ontario, any gift funneled into the family home is unprotected. Accordingly, since loans remain enforceable, gifting rather than loaning can be an expensive mistake if your daughter’s marriage later unravels at the seams and she happens to live in Barrie, as mentioned earlier. (To be clear, I actually quite like Barrie, just not Ontario’s spin on how the house is divided upon divorce.)

Document the gift in writing, preferably in front of an independent witness, so you can prove both that it was a loan and its terms. On the latter point, if you are looking to charge interest or have a repayment schedule, documenting the intentions in writing may avoid some misunderstandings and awkward conversations down the road.

If charging interest, consider a variable rate loan pegged to a benchmark, or, if you really, really like fixed-rate mortgages, include rate reset provisions further out in time, such as every 5 years, as well as a formula, such as pegging rates to bank rates at that time for a similar mortgage. Although you may not always pass along any rate increases, it’s a lot easier to waive or modify terms in the future if you’re feeling generous than to ask for a rate increase out of the blue later in life when you’re charging 5% less than current mortgage rates or what you’d hope to get if investing the loan money elsewhere.

If really worried about protecting the loan, such as if your child is not exactly a financial superstar or they might sued at some point in the future, consider registering the loan against the property like banks do when providing mortgages. On a practical level, if the child also has a bank loan, this may present problems or you may need to grant the bank the right to get paid first if there is ever a forced sale, but this option is at least worth investigating if you start to hear about your child missing credit card payments.

Consider requiring your children to sign a prenuptial as a condition of a loan if his or her spouse or their family aren’t contributing as much towards any home purchase or your child goes into the relationship with a lot more wealth, particularly if (s)he already has children from a previous relationship. This might be the pretext your child was looking for but was too love-struck to bring up in casual conversation. You playing bad cop, albeit one with a large cheque book, may ultimately save your child a lot more than the value of any loan should their relationship go south. Moreover, prenups and cohabitation agreements also cover off Will challenges. Although your child may not live to see the benefits of the prenup, his or her children may be the ultimate winners when the stepfather or stepmother of your grandchildren is prevented from claiming more of the estate at your child’s death than your child had wished and bargained.

Make the loan to both your child and their partner so that you can potentially collect from either of them. This provides you with more protection and flexibility. For example, on your child’s death, it is easier to collect from the spouse or at least protect the value of the loan if the spouse enters into a new relationship. Some parents may still forgive the loan at their own death, but others like the idea of gifting the remaining loan balance to their grandchildren in trust in order to ensure that they get at least that much of the house one day.

If you do need the money back one day, be clear on a timeline, such as an event like retirement, your 65^th birthday or when the child renews the bank mortgage in 5 years. Not only does this help with setting expectations, but it also allows your child to budget for this eventuality when managing their own finances, which vastly increases the chance that (s)he actually has the resources to make this happen when the target date arrives.

Talk about the loan in your Will. If you plan on forgiving it, say so. If you want it deducted from a child’s share of your estate instead, say that as well. If nothing is said, it will be treated as a loan to be repaid most of the time, but why leave it to chance? Even if that is your intention, any uncertainty can lead to bad feelings among the rest of the family if they don’t agree on what you really wanted to happen. And, if you want the loan transferred to someone else, like a grandchild, say that as well.

As mentioned earlier when discussing gifts, if you haven’t loaned to your other children at the time of your death and have interest-free loans to others, do any equalization payments to the have-not kids need to be bumped up beyond the mere value of the loan to level the playing field? Consider charging notional interest (but don’t make the calculations too complicated) to increase the amount of any equalization payment. For example, I have had some clients add amounts like 5% per year to the value of any previous loans when determining how much the loan-free children should get before the rest of the estate is divided.

Going on Title – Helping But Not Necessarily Giving

There are several different scenarios where mom and dad might actually end up on title to a child’s house. I won’t pretend to cover all of them, but I’ll point out a few scenarios where this might either be required by the bank or something you might want to do for other reasons.

The most common situation is when the child can’t qualify for mortgage on their own and the bank won’t give them the cash unless you’re both on title and are also responsible for ensuring that the bank gets their biweekly pound of flesh. Although it is theoretically possible for you to stay off title but only guarantee the mortgage, I haven’t seen this actually happen, unfortunately. Typically, the parents required to be on title take a 1% interest (although you may want a bigger stake as I’ll discuss later), which is the minimum amount necessary to appease the bankers. If this is unavoidable, so be it, but lawyers really do hate it when clients end up guaranteeing someone else’s loans, which is what you’ll be doing when signing onto the mortgage. It’s one thing to write a child a cheque for a set amount and knowing that is all you might lose, but something completely different to know that you might be called on to make someone’s ongoing mortgage payment or perhaps a lot more. Although there will hopefully be enough equity to pay the bank back should this happen, there are no guarantees. Moreover, it is generally a lot better for Christmas dinners in the future when family finances aren’t connected at the hip. Anyway, if guaranteeing or being a copayer of a mortgage is the only way forward and you’re comfortable with the situation, at least proceed with your eyes wide open.

In other cases, perhaps mom and dad want more than just a thin slice of the new place. For example, if they are providing a 30% down, they might want 30% ownership. For parents considering taking on a larger ownership stake, here are some more of the pros, cons and suggestions, using this 30% ownership example:

If a child’s relationship fails, you are entitled to at least 30% of the equity rather than just the amount you originally contributed. On the other hand, this may not be as good as it sounds. If the place has declined in value, you might get back less than you invested. Moreover, if you have funded the entire down payment and the rest was mortgaged, your 30% of the equity may actually be less than your original contribution even if the property has gone up in value. For example, if you contribute the entire $300,000 downpayment for a $1,000,000 property and take back a 30% ownership stake, you could potentially still lose money if the property sells the next day for $1,100,000. Although the total equity has increased to $800,000, unless you have a proper agreement in place that ensures that you get your original contribution back first, you may only be entitled to 30% of $800,000 or $240,000. Accordingly, a written agreement is a wise insurance policy for any time you’re co-investing with a child, particularly if they have already coupled up or might find that special someone in the future.

“Going on title” ensures that the child cannot sell or borrow additional funds against the property without your knowledge, and in most cases, consent. If you merely have a written loan agreement without registering a mortgage against the property, your child can do as they wish. For younger or troubled children, or if you have control / trust issues, this may not be an acceptable risk.

You’ll have more to pass along to grandchildren or others compared to merely calling in a loan or transferring it to grandchildren if your child predeceases you. Although transferring a loan to the grandkids does provide some benefit, the value of any loan will not have increased along the way and the spending power of any loan 15 years down the road is likely a fraction of what the money was worth initially, which means a lot less to pass along to junior’s own children in real dollars. If you have a piece of equity to pass along instead, hopefully the value of your piece of the pie will be a lot more significant.

Unless you’re also living in the house with your child, which is something becoming more common, your percentage of the property probably won’t qualify for tax-free growth under the principal residence exemption. While your child’s share of their home will still sell tax-free, your portion of any growth will be taxed as a capital gain. If weighing choices, particularly if you don’t need the money back and plan on gifting it to the child at death, the tax hit that could have been avoided if the child was the only one on title is one of the biggest negatives. Noting the typically high tax rates people face at death, this could mean losing 26.75% of any increase in value to the tax man.

If you have to borrow to come up with the money and may be cash-strapped for your own retirement, taking an equity position, along with that written property agreement I am harping on about can be a win / win result. This also assumes that the child can either pay you out (such as by refinancing) or is willing to sell when you need your retirement dollars. It’s also possible to sell in stages to make this more affordable, which might also save you some tax dollars by staggering any capital gains over multiple years rather than having it all taxed in a single year. Ultimately, this strategy is essentially investing with your child rather than with your stockbroker to fund your retirement. The key is ensuring that you’ll be able access your capital when you need it.

When co-owning property with a child, here are some suggestions when looking at a written agreement:

Don’t try to do it alone. Get a lawyer involved and ensure that any agreement either says the others got independent legal advice or were advised to do so.

Have your child’s spouse be a party to the co-ownership agreement. This offers greater protection if your child dies or divorces. Although you don’t need to enforce every part of the agreement in every situation, why not have that option?

Clarify who is responsible for ongoing costs related to the property or how they are to be apportioned. This is particularly important if there is a mortgage or if renovations are likely in the possible.

Particularly if you’ve paid most or all of the purchase price and the child is covering all of the mortgage, determine how the equity is to be divided when the time comes. For example, do you get your down payment back and your kid gets any amount paid towards the mortgage back before the rest of the equity is divided?

Include provisions for when you can compel the sale of any property if the kid can’t or won’t buy you out, such as at your retirement or various deaths or any time you want with a set amount of advance warning.

Consider adding restrictions on using the home as collateral without approval of the other parties.

Require mandatory mediation and binding arbitration instead of court if there is a problem with the agreement. This may be particularly useful if something happens to your child and you have to deal with that unreasonable son or daughter-in-law.

Consider if any of the parties want to have life insurance on the others to pay for a buyout on the key person’s death.

If you want the child to receive any remaining equity on your death as part of their inheritance, clarify how the place is to be valued, particularly if that child might also be your executor, in order to avoid any conflict-of-interest worries. This might simply mean requiring a professional property appraiser paid for by your estate. Also, specify which costs should be paid by the child receiving the property should pay and which you want covered by your estate.

Final Words

Helping children own their own home can not only be a family affair, but also a shared dream. The goal is to prevent any generosity on your part from turning into a nightmare. Fortunately, there are several ways of protecting against things go wrong. Taking the time to carefully consider your options and to document your intentions can ultimately make all the difference.

Mar 27

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What to Do If Your Kids Are Not Too Cool for School Part Three: All About In Trust For Accounts

A good education can be invaluable, but it seldom comes for free. In these days of rising housing costs, interest rates and taxes, it is getting harder and harder for some families to help younger family members get that education. In my last article, I devoted a few thousand words to the most common way of funding these pursuits – Registered Educational Savings Plans or “RESPs”. Today’s missive focuses on another way to help fund an education, even for families that have already maxed out RESPs: In-Trust for Accounts or “ITF Accounts.”

Despite their benefits, RESPs may not be a one-stop solution, particularly if Junior has Ivy League aspirations or educational pursuits that seem to span decades. For other families, the numerous rules surrounding RESPs and penalties that can arise if a child doesn’t go to school or use up all of their grants and gains, may cause them to look for a more flexible alternative.

That’s why families look at other educational funding strategies as either an alternative to or in addition to RESPs. ITF Account are one of those choices and, on first blush, there seems like there is a lot to like: less initial paperwork, no funding limits and more flexibility on the back end should junior wishes to busk rather than earn a baccalaureate. The tax savings while junior is a minor also offer appear to offer tantalizing tax savings – accounts funded through an inheritance, a gift from a foreign relative or by the Canada Child Tax Benefit allow all income and gains to be taxed on the child’s return, although ITF Accounts funded from other sources usually tax income (but not capital gains) in the hands of the contributor while the child is a minor.

Unfortunately, despite the surface appeal, there are some significant drawbacks to ITF Accounts and some practical complications that might get in the way of some of the theoretical tax savings. Read on and decide for yourself whether ITF Accounts are an ingenious solution or a problem just waiting to happen. Before I begin, a quick shoutout to Canadian Moneysaver Magazine reader Claire Scribner for her invaluable questions and comments!

Basic Principals

From a legal and tax perspective, ITF Accounts are informal trusts, which means that they operate according to the same basic principles of those elaborately detailed written trusts that I’ll talk about in my next article, but without all the structure, details, costs and paperwork that goes along with their more glamorous cousins. That means that there is someone managing the assets (“the trustee”), on behalf of the person who is entitled to the benefits of the account (the “beneficiary”). Thus, many parents are the trustees of ITFs for which their children are beneficiaries. Theoretically, ITFs should be taxed inside the trust and all income or realized gains not distributed or deemed to be distributed taxed at the highest margin rate for the trustee’s province.

Is It Really AN ITF Account?

As is so often true, however, life is more complicated than it may appear at first glance. First, it may be debated whether you’ve actually created a trust at all by the CRA since certain legal formalities are required and ITF Accounts rely on solely the account opening documents rather than the lengthy trust documents that go with a formal trust. It could be that you’ve merely opened a non-registered account earmarked for the child that should be taxed in your name or you’re acting as agent for the child and their babysitting funds rather than as a trustee. If all of this sounds confusing, then you’re not alone. If you want to establish a true ITF account, you’d want to confirm the intention to gift, the items to be gifted and identity of the person entitled to benefit from the largesse. The account opening documents should hopefully clarify the trustee and the beneficiary. Ultimately, this can be a lot to expect from ticking some boxes and filling in a few blanks.

Moreover, the CRA would also look at who has been paying the tax on ITF Accounts. Since ITFs generally don’t apply for a trust number (which is like a SIN number for trusts) and minors cannot establish their own investment accounts, ITFs are typically opened using the trustee’s SIN number. As a result, all tax slips for the ITF will also be issued in the trustee’s name. That means that if the trustee doesn’t report the income and gains on their own tax return, the CRA automatically picks up on that and starts sending out nasty reassessment notices. Although an accountant friend of mine advises that it may be possible to then go back and forth with the CRA about this every year, the hassle factor and potential accounting costs if someone else is doing this may not be worth it, particularly if the ITF is not a large account and / or the income would have otherwise been taxed in the adult’s hands anyway (such as if a parent funded the ITF). As a result, despite the best of intentions, if the trustee has been paying tax on the income and gains, that might be enough for CRA to deny that a true ITF had been created.

In some cases, in fact, this denial may be a blessing in disguise. If the account is treated like a trust and none of the income or gains have been paid out of the trust or promissory notes for these amounts payable to the child issued, the CRA can argue that the income and gains should be taxed in as trust, which means at the highest marginal rate inr the trustee’s province of residence. In other words, the ITF account might become a tax albatross rather than a tax saver.

For those willing to go the extra mile and fight this battle, such as when many years of tax savings still lie ahead and you think you’ll be able to tax even income in the child’s hands, I suggest that the trustee treats the ITF like a formal trust, which requires the following:

All taxable income or gains should either be taken out of the account and spent on the youngster, or the trustee writes formal promissory notes on behalf of the ITF to the beneficiary for these amounts that are immediately cashable, although mom and dad are still entitled to blithely ignore junior’s demands for the cash until (s)he come of age. This hopefully prevents the CRA from taxing the income in the trust at that province’s highest marginal tax rate.

Document your intentions to create a trust through a separate document when opening the ITF Account and be consistent in stipulating who pays the tax on the income and gains each year.

Investigate getting a formal trust number from the CRA and using that number for the ITF’s bank or investment accounts rather than the trustee’s personal SIN number. Expect a lot of questions from those financial institutions and hassle regarding where the money has come from and request for details.

Assuming you survive the administrative quagmire of actually opening accounts in the ITF’s name, be prepared to file annual trust tax returns on behalf of the ITF. The rules and disclosure requirements for trusts are in the process of changing significantly. At this point, the proposed legislation suggests that ITF Accounts worth less than $50,000 owning things like GICs and publicly traded securities may not always have to file tax and information returns, depending on their activity that year, but this may change.

If hoping to get all income taxed in junior’s name under one of the previously listed exceptions to the general rule, don’t commingle (a word I try to fit into daily conversation) money qualifying for an exception with money that does not or risk having income taxed in the trustee’s hands.

Keep records, records and more records. This means tracking the source of the ITF funds, particularly claiming an exception to the general tax treatment of income, as well of the expenses mom and dad paid on junior’s behalf that the trust is reimbursing.

Some other Potential Benefits of ITF Accounts

Although having capital gains and, perhaps, income taxed in the youngster’s hands can be a wonderful thing, particularly it’s still many years before (s)he’s old enough to buy their first drink, ITF Accounts may provide some other benefits in the right circumstances, including:

Protecting assets for the child if the parents get divorced or, perhaps, against creditors, since the money in the ITF no longer belongs to the person funding the account. If it doesn’t legally belong to the trustee and (s)he didn’t fund the account 10 minutes before filing for bankruptcy, ITF Accounts should ultimately live to fund another day.

Avoiding Will challenges, taxation, probate fees and unexpected results at the trustee’s death. Although ITF Accounts can have other problems if a trustee dies within money still in a child’s ITF Account, it should still belong to the child beneficiary, regardless of the deceased’s Will. If the money was just kept in a separate non-registered account in the dead trustee’s name, it would be distributed according to the deceased’s Will. Accordingly, unless the trustee’s Will specifically says that the non-registered account passes to the child, it would be distributed as part of the residue of the estate where it might pass into unintended hands, could be scooped up by estate creditors or tied up in Will challenge litigation.

Why ITF Accounts Keep Lawyers up at Night

Even if you thrill at the thought of the extra paperwork and never turn down the chance to bicker with the CRA, there are many other reasons why you may wish to give an ITF Account a hard pass. Here are some of those scary contingencies:

Loss of flexibility and control. Once the money is gifted, the money belongs to the child. That means that before your child is old enough to drink in the US, they have the absolute right to demand their money and spend it as they wish. Accordingly, if you’re worried if your child has a thing for fast cars and trips to Maui, an ITF Account might be a ticking timebomb. On a related note, the money cannot be used for anyone but the child, no matter what life surprises await. A non-registered account without the tax advantages of an ITF Account allows the parents or grandparents to retain control of the money if the child goes off the deep end or it turns out later that the money would ultimately be better spent on themselves or another family member.

Estate complications on the child’s death. If the child dies with money in the ITF Account, it becomes part of that child’s estate. Since most children can’t or don’t have valid Wills, that means that the money will be distributed according to the laws of intestacy in that province. In addition to potentially paying probate fees and expensive court applications in order for someone to manage that estate for the dearly, the money may end up in the wrong hands. For example, how would you feel about your ex-spouse getting 50% of the ITF Account you funded by working overtime and forgoing vacations if your child died without dependants or a spouse?

Complications on the trustee’s death. Unless the trustee’s own Will stipulates who manages the ITF account, the task will generally fall to his or her own executor. This person may not be right person for the job, particularly in blended family situations when your new wife ends up managing the account a stepkid.

Potential liability for inappropriate investment decisions. Admittedly, this is a stretch, particularly for smaller accounts. All the same, I strongly recommend against a penny-stock heavy strategy, as trust law says that all investment decisions should be reasonable ones depending on the timeline and intention for the account.

The Bottom Line

While ITF Accounts can play a valuable role in educational funding in the right circumstances, I don’t see them as the best alternative in many others. I am far more comfortable with them in the following circumstances:

The child is already close to university age and has already demonstrated that they have their act together.

The person funding the account is okay with the child using the money for other purposes should the child not go to university or have money left over afterwards.

The funder has ample other resources should life through them a curveball.

The account size isn’t so small that it’s not worth the hassle or complications and not so large that it would be a catastrophe if things went wrong. For larger amounts, a formal trust is a far safer option that cover off what happens if things don’t work out and provides the trustee with far more control, including not requiring a full payout at age 19 or allowing distributions to other beneficiaries in some circumstances, such as a single educational trust for a group of children or grandchildren rather than pinning all of your hopes on a single child / grandchild.

The trustee is a details person.

Income and capital gains will both be taxed in the child’s hands (or the account is set up to minimize taxable income until the child is an adult) and would otherwise be taxed in the gifter or trustee’s hands at a much higher rate so that there will be enough tax savings to make the risk and hassle worthwhile.

Dec 5

What To Do If Your Kids Aren’t Too Cool For School: Educational Funding Strategies for Tax Stingy Families

It takes a lot to pay for an education these days, without even considering all of the bonus expenses in addition to paying for tuition and textbooks. And it’s been getting harder. Tuition costs have been consistently increasing at a rate higher than inflation and some of the previous tax-efficient funding options, such as paying dividends to students over 18 from the family business, are no longer on the table in most instances. Adding to the pain, tax rates for higher income earns have increased drastically over the last 5 years, making it that much harder for these families to accumulate and grow enough sufficient funds to put the next generation through school, particularly when saving for multiple children. And let’s not even talk about how the cost of housing eats into many family’s savings plans. Although a good education can be priceless, actually paying for it may be beyond the means of many. Alternatively, the resulting student debt can leave many struggling students financially crippled and stressed for years to come.

Although there is no universal silver bullet that can save the day or convert pennies into portfolios, there are some strategies that can at least make life slightly easier and more affordable in some cases. In others, however, the savings can be far more profound.

Basic Principles

As is so true with many planning strategies, the earlier you can put things in motion, the more significant the potential benefits. Just like any other savings strategy, the more time the money is left to percolate and grow, the larger the benefits. Obviously, this isn’t always possible. But if the problem is simply a lack of knowledge of some of the options available, then that’s an entirely different kettle of fish. If any of today’s or my future offerings resonate with you, your pocketbook and your reality, I encourage you to take the next step, whether that means gathering more information or actually putting one of these ideas into motion.

Planners typically start by looking at the big picture before drilling down into the minutiae and, because no one likes to feel like they’re not fitting in, I will do the same. Before weighing the different ways of funding junior’s liberal arts degree, here are some BIG PICTURE musings I suggest contemplating first.

The Early Bird Gets the Educational Worm

Sometimes Education Can Be a Family Affair

This point ties in nicely with the last one. For many parents, there are far more pressing financial concerns than funding a child’s university education 15 years hence. Paying the mortgage, maximizing RRSPs, saving for that first home, ensuring they have enough insurance in place to protect the family upon death or disability, paying off their own student debt or simply keeping their own financial head above the water may all take priority over hopefully sending junior to Harvard or trade school someday. That’s where other family members may be able to lend a hand. Many of my grandparent clients are passionate about ensuring that those cute little people that are part of their gene pool are given every opportunity to achieve their educational dreams and career aspirations. While I strongly encourage these grandparents or other family members to first ensure that their own financial nests are well feathered with a large margin of error, if this is not a concern, then they might want to take a more active role in ensuring that young Dick or Jane will be able to afford school when the time comes.

In some cases, grandparents are reluctant to pry into what they see as their children’s financial affairs. And, in other instances, I have seen parents who are reluctant to talk about these issues with their own parents if money is tight or to accept assistance when offered. In both cases, the ultimate losers might be the grandkids. Accordingly, although I know this isn’t always possible or even desirable, I encourage both parents and grandparents to consider proactively discuss plans for educating that those fingerpainting youngsters who may one day want to become astrophysicists. In fact, feel free to share this article with parents or children as a springboard to making this happen.

One Size Doesn’t Fit All

One of my pet financial planning peeves (yes, I know that this makes me sound like a geek) is reading articles that seem to suggest not only that there is one way to skin a cat but telling you which cat to skin first. Admittedly, some suggestions like “get a Will” are hard to contest, but this is not one of those instances. Each family is different, both in terms of their finances, but also in terms of their needs, goals, values, problems and interpersonal dynamics.

Figure out your own priorities and values and then act accordingly. And, in some cases, this may mean requiring the child to fund their own education in full or part rather than making life too easy for them or sacrificing some of your other financial needs or goals.

Meet the Players

I will eventually devout a separate article to each of 4 different ways of savings for a child’s education but wanted to first introduce you to the entire cast of characters before shining a separate spotlight on each. Accordingly, the summaries below are not intended to provide you with a complete list of the good, bad and ugly. As a final warning, this article is written based on the assumption that all parties involved are Canadian residents and citizens. If this is not the case, you’ll need to discuss how this affects your potential plans, particularly if someone is a U.S. citizen or resident.

Registered Educational Savings Plans (“RESPs”)

A Registered Educational Savings Plan provides 20% government matching on qualified contributions and allows income and gain within the plan to grow tax-free along the way, with the government grant money (“CESG”) and all plan profits / income taxed in the name of the student upon withdrawal if still in school. The original contributions, which were made with after-tax dollars, are tax-free upon withdrawal, while the grants and gains will be taxed as income. There is a lifetime funding limit of $50,000 in contributions per child and the government CESG are capped at $500 per year, but with an extra $500 in catchup grants per year, to a lifetime CESG grant maximum of $7,200.

The government grants and tax-free compounding make this a very enticing option for many families, but yearly funding caps and maximum funding limit per child both get in the way of maximizing the size of RESPs by the time the children finish high school, which can be of concern if the student has Ivy League potential or has plans to be in school for a long, long time. Accordingly, in some cases, the RESP may be part of the solution but not a complete answer to the question. Moreover, if the child doesn’t use up all of the taxable money, it may need to be taxed in the hands of the parents, with an extra 20% added on, but up to $50,000 can be rolled into an RRSP if the funding parent has enough leftover room, although that parent won’t get the normal tax deduction associated generated by RRSP contributions when taking advantage of this option.

In Trust For Accounts (“ITF Accounts”)

ITF accounts are considered as informal trusts, which means that they don’t have the written trust deed, contingency planning and specifications that go with a formal trust, but they also avoid the resulting setup and ongoing administration costs. There is no limit on how much can go into these accounts, nor when. As well, all capital gains earned in this account will always be taxed in the child’s hands at the child’s rate, but any income (think interest or dividends) will be taxed in the contributor’s hands while the child is under 18, unless the money in the account came from an inheritance left for that child or the Canada Child Tax Benefit, in which case the income would be taxed in the child’s name.

Although taxation is not deferred in ITF accounts, if the youngster is not a child model or the proud owner of a very lucrative paper route (assuming those still exist), there would likely be no or a minimal tax hit on all income taxed in the child’s hands.. Because dividends are far more tax efficient than interest income, which is how RESP taxable withdrawals are essentially classified, there may be less of a tax hit and more tax flexibility over these funds after the child is 18. Moreover, there is no restriction on how the money is used, so if the child wants to be a student of life rather than a podiatrist, there aren’t the same potential tax problems faced when a RESP is set up in that child’s name.

On the other hand, there are some significant potential problems with all that flexibility I just discussed. In fact, as soon as the child reaches the age of majority in their province of residence, they have the legal right to demand the money and do what they want with it. Just like for most formal trusts, once the money is contributed to an ITF account, it is no longer owned by the gifter. Accordingly, if the child wants to spend all of the carefully accumulated cash on a fast car, designer clothes and a trip to Maui, then that child might be off to the mall.

On another note, if the ITF account wasn’t funded with the previously mentioned inheritance or Canadian Child Tax Benefit dollars, then any dividends or interest will be taxed in mom and dad’s name at their rates until the year the child turns 18. As a result, if the funder is in a higher tax bracket, the money will not compound nearly as much as within an RESP. Although many of us love, love, love eligible dividends, for people in the highest tax bracket, we could still be looking at over 40% taxation in some provinces.

Finally, if anything happens to the child or the person in charge of the account, there could be a mess. As the funds belong to the child, it will become part of the child’s estate, which could mean the wrong person eventually inheriting. If something happened to the person managing the money, then that person’s executor would take over management of the ITF account, which may not be ideal, unless perhaps the deceased’s Will specified who would be handed the reigns.

Ultimately, these accounts can work well when the stars align but you will need to ask yourself whether you inhabit such a world or, at least, what you can do to minimize risk. Ultimately, I suggest investigating other options when larger sums are involved or the youngster in question has a habit of playing with matches, playing online poker or buying $500 jeans with rips in them.

Formal Trusts

As also a practicing Wills and Estates lawyer, I admit to having trusts on the brain. But hear me out. In this instance, there are a couple ways that trusts can go a long way towards paying for a few university degrees or trade certifications.

Put simply, a trust a separate entity for tax purposes set up with specific assets and instructions, particularly how the assets are to be distributed. Many trusts are set up to allow the person administering the trust (the “trustee”) maximum discretion as to who gets what. If done correctly, the income and gains from the trust investments can be taxed in the hands of the recipients (the “beneficiaries”) rather than the original owner. And if the beneficiaries are earning no or minimal income, the tax savings over time can be massive.

Trusts Created and Funded by Living People

The trusts I draft for parents trying to pay for their children’s current or future educations require mom and dad (or whoever else sets up the trust) to loan the money to be invested inside the trust at a minimum government rate (currently 1%) that is fixed for the life of the loan. Without these low-interest loans, income would be attributed back to the contributor while the child was under 18 just like for most ITF accounts. With the required loan in place, mom and dad, can allocate income and gains earned in the trust to their progeny or other family members with impunity.

If the child is already incurring significant expenses, the trust can essentially repay mom and dad for covering these expenses on behalf of the wee ones or pay those costs directly. If there is excess income or gains, the trust could instead pay these amounts to the parents to be taxed in their names or essentially write the kid an interest-free IOU or Promissory Note and leave the money in the trust to compound. Down the road, such as when the child starts university, these IOUs can be paid out tax-free to the child to cover education costs.

Besides set up and annual costs, one of the biggest concerns if what happens if the child goes off the rails. If all of the annual income has been paid out to cover ongoing expenses, then the child has no right to demand anything else from the trust. On the other hand, just like for an ITF account, the child can demand repayment of any Promissory Notes owing when an adult without restriction. Similarly, if the child died prior to cashing in the Promissory Notes, they would become part of the child’s estate, which might see the money eventually end up in an unintended place. Accordingly, it may be a good idea for the child to write a Will or have a Power of Attorney in place when the amounts start to get significant.

I’ll have a lot more to say on this type of trust in a separate article, but I hope this teaser is enough to give you an idea of the potential benefits. And it’s not only mom and dad who might end up loaning money to the trust – grandma and grandpa might be the ones loaning the cash, which might help them keep more of their OAS pensions by reducing the amount of income that might otherwise be reported in their hands, or allow them to drawn down their RRIFs if worried about a big tax bill at death. And, if grandma and grandpa are setting up this type of trust, they might add additional beneficiaries, such as both children and grandchildren, while also stipulating how the money gets divided at their death.

Trusts Created in Wills

Grandparents hoping to help fund a child’s education if no longer around may set up trusts in their Will to make this happen. For smaller amounts, it isn’t usually feasible, but for larger amounts or if creating a single trust for multiple grandchildren, this might be a very tax efficient way of educating the young. And, unlike the trusts mentioned in the previous section, there is no 1% loan requirement so 100% of the net income can be allocated to the grandkids.

In addition, I am helping grandparents fund their grandchildren’s education in another way by setting up Wills where they leave their children their inheritances in trusts rather than in cash. These trusts allow the children to control what happens to the inheritance but also names their own children (i.e., the grandkids) as discretionary beneficiaries for income splitting purposes. As a result, the child can make their inheritance go further by allocating income and gains to their own children so it is taxed at child’s rates. That parent could control the capital of the trust and could prevent too much money from getting into the grandchild’s hands too soon by only paying out enough income to cover expenses if the trust was drafted to be flexible, unlike an ITF. On the other hand, the trust could instead provide specific instructions regarding funding the grandchild or grandchildren’s education if grandma and grandpa wanted to make sure that their children abide by their wishes.

As a final benefit, the trust could stipulate that the grandchildren inherited whatever was left down the road when their parent also benefiting from the trust died. By contrast, if that parent had inherited directly, (s)he would typically leave the remainder to their spouse instead, which can lead to many unintended circumstances, particularly if that surviving spouse is a poor money manager, remarries or has other children. Needless to say, many grandparents aren’t too keen on those alternative outcomes.

Again, there is a lot more to be said on the subjects of trusts. This article is merely intended to whet your appetite and to seek out additional information from your legal advisor if this option sounds intriguing.

Permanent Life Insurance on Children

Buying life insurance on the young is simply too ghoulish for some and I understand that completely. On the other hand, there are many practical reasons for buying policies on children or grandchildren that you may wish to explore. For example, permanent life insurance can be a very tax efficient long-term savings vehicle. Certain policies allow additional contributions that compound more or less tax-free, and the policies can be transferred to adult children or grandchildren without triggering tax so that any withdrawals (such as when the child decides to go to grad school and the RESP is now only an empty husk) can be taxed in the child’s hands. Moreover, unlike ITF accounts, the policies still belong to mom and dad until they officially roll the policies over to the children, which may provide far more peace of mind that setting up an ITF account shortly after a child’s birth and rolling the dice on the child’s future good behaviour.

Just as for the other introductions, there numerous other details to discuss, but let’s leave that for another day.

Conclusion

Paying for a child’s education can be daunting task for some and near impossible one for others. And it’s been getting harder. On the other hand, with the right plan and proper execution, things can at least get a little bit easier. The next articles in this series will both flesh out the details on the options summarized above and also provide suggestions on how to optimize each approach. Next time, I’ll share some strategies to maximize RESPs.