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The Ultimate Guide to Informal Trusts
Some lucky people may be fortunate enough to have excess funds for the children in their lives. If this is you, congratulations! It’s no small feat to reach this level of financial abundance.
However, when considering what to do with this money, you may be faced with some issues:
- The kids’ RESPs are fully topped-up.
- They’re too young for TFSAs.
- They have no earned income for RRSPs.
- Kids’ savings accounts pay almost no interest.
Is there any way to put this surplus money to work? Why yes, there is! You can open something called an informal trust (otherwise known as an ITF or “’in-trust-for” account).
Informal trusts aren’t as well-known as I think they should be, and I hope to shed more light on them with this post.
About this post
When researching informal trusts, I found the articles on these accounts to be light on helpful info and heavy on scary, vague warnings. To me, they mostly seem to say:
“Informal trusts can be great! But they’re not formal trusts (which are legal and valid because they’re written by lawyers). Due to the lack of formality in informal trusts, you could be setting yourself up for a world of trouble by using them. That said, we still think they’re great! But we’re not your advisors, so we’re going to keep things very vague and won’t tell you what to do (or not do). Good luck!”
That’s not very helpful, is it?
Time to bring in some clarity
I wanted to do better with this post. Instead of repeating the same vague warnings, I made it my goal to provide actionable info and clarity. To do this, I enlisted expert help from (in my opinion) the best financial planner in Canada—Ed Rempel.
Ed has decades of experience in financial planning, tax accounting, and informal trusts. (And, full disclosure, he’s also my financial planner.) Generously, he agreed to answer my many questions about informal trusts and gave me permission to share his replies with you in this post.
About Ed Rempel
Ed Rempel is “the main Wise Guy” on his blog, Unconventional Wisdom. He’s also a fee-for-service financial planner and tax accountant with a ton of real-life financial planning experience.
Ed and his team have been using informal trusts (aka ITF accounts) for 25 years. They have plenty of experience with them and work with CRA’s and all the investment firms’ informal trust rules.
In this post, I will (with Ed’s help) attempt to ease your worries and give you the straight goods on informal trusts. But don’t forget: I’m not a qualified expert, and Ed is not your financial planner, so have a read through the below disclaimers before proceeding.
- I sourced most of the information in this post from websites and PDFs I came across in my research. When I couldn’t find factual, clear info, I turned to Ed for the answers.
- Throughout the post, I’ve made an effort to be clear when Ed provided the info. Everything that’s not credited to Ed is based on my own experience or interpretation of information I found in my research.
- I’ve made every attempt to be accurate with the info shared in this post. However, please consult your own expert(s) and do your own research and due diligence.
- This info is provided as general information only and should not be taken as financial or legal advice.
Part 1: The basics of informal trusts
This section will cover the basics of informal trusts, including what they are, terminology you’ll come across, and how they compare to formal trusts. Let’s start with some of why you might want to consider an informal trust (or in-trust-for account).
Q. Why consider an informal trust?
Ed suggested that we start this post with why you might want to consider an informal trust or ITF account. Here are his top reasons:
1. Saving for “anything else”
RESPs are best for education savings, but ITF accounts are usually best for saving for anything else. RESPs should be withdrawn fully while the kids are in university, so they are not good for anything the kids will want after university.
2. Saving for future large expenses
ITFs are getting more common. The main uses are education savings above the RESP limits and a down payment for their first home. With real estate getting out of reach for young people, ITF accounts are a great place for parents to save a down payment.
3. Tax-free growth
With proper tax planning, investments in ITF accounts provide essentially tax-free growth. (Assuming you crystallize gains before they get too big—see the taxation section for more on this.)
Q. What’s an informal trust?
Informal trusts are also known as ‘in-trust-for accounts’ or ITF accounts. They’re a type of non-registered account that allows an adult to invest on behalf of a minor child.
Typically, the adult(s) will be a parent, grandparent, aunt, or uncle. But any adult can open an informal trust for a child. There are several benefits to informal trusts, but the main benefit is their tax efficiency.
Informal trust terminology
- ITF (in-trust-for) account: Another name for informal trusts.
- Contributor or donor: The person who contributes to the child’s informal trust.
- Beneficiary: The minor child who benefits from and is the legal owner of the informal trust.
- Trustee: The person who manages the informal trust.
- Settlor: The person who creates or ‘settles’ a trust. (This term usually is only used when referring to formal trusts, but you may see it referenced in articles about informal trusts.)
- Second-generation income: Income earned from first-generation income.
Q. What are the differences between formal and informal trusts?
Formal and informal trusts are both valid and legal, but there are important differences. Here’s a comparison:
|Formal trust||Informal trust|
|Must be drafted by a lawyer.||Quick and easy to open; does not require a lawyer.|
|Expensive to set up and maintain. (Lawyers and accountants are usually required.)||No or minimal cost to set up and maintain.|
|Comprehensive and complex structure and taxation.||Straightforward structure and taxation.|
|Provides more options, protections and control.||Offers less protection and control once child is of legal age.|
|Is more likely to stand up if contested or challenged.||If not correctly set up, may not be recognized by CRA; penalties and back taxes may be assessed.|
Q. Which is better: formal or informal trusts?
The answer is, it depends. From what I’ve read, formal trusts start at around $1,000 to set up. After that, there may be ongoing fees to pay a trustee to manage it.
In addition, there are other factors to consider when deciding on a formal versus informal trust:
- Can the child be trusted to manage the money responsibly when they reach the age of majority?
- Would you like greater control over how much the child receives from the trust and when they receive the money?
- Are there other reasons which would justify the need for increased protective measures in the trust?
I suspect that informal trusts will be the best choice for most families. But your specific situation may dictate otherwise. Consider your needs and wants to decide which is best for you.
Part 2: The benefits of informal trusts
There are many benefits that are unique to informal trusts:
1. Tax advantages
Informal trusts are not tax-sheltered (like RESPs), tax-free (like TFSAs), or tax-deductible (like RRSPs), but they still offer significant tax advantages.
These tax advantages are, by far, the biggest reason why people choose to open informal trusts. Here’s how taxation works with investments held in informal trusts:
- Income (e.g. interest and dividends) is taxed in the hands of the contributor or trustee.
- Capital gains are taxed in the child’s hands (which typically means they’ll pay little or no tax).
Even better—in some cases, the income can also be attributed to the child!
See the taxation section for more details on these tax advantages.
2. Simple and easy to use
Another benefit of informal trusts is their simplicity:
- They’re free and easy to open.
- They’re easy to use and maintain.
- Most (if not all) brokerages and banks offer them.
- They don’t require professional help to set up or maintain.
3. More flexible than RESPs
While I think RESPs should be the first choice for kids’ investment money*, they’re not the right choice for everyone. In addition, some lucky families have already filled their RESPs and need another account to invest their childrens’ money.
In these cases, you’ll be glad to hear that informal trusts are a great alternative (or companion) to RESPs. Here’s why:
- There are no limits on contributions or withdrawals from informal trusts.
- There are no restrictions on how the money is used (other than it must be used for the beneficiary’s benefit).
- You can hold USD investments in informal trusts—with no expensive or troublesome workarounds.
- Informal trusts don’t require a stack of paperwork or long wait times to open up.
- If the child is in a higher tax bracket when they withdraw, funds from an informal trust will be taxed more lightly than funds from an RESP.
4. Simplifies recordkeeping
Holding the child’s investments in their own account helps to simplify recordkeeping and tracking. (As opposed to commingling their money in one of your own investment accounts.)
When they reach the age of majority, transferring the assets to the child will be straightforward (since the assets are already legally theirs).
5. Pride of ownership
Another benefit to holding a child’s investments in their own informal trust is that it gives them a greater sense of ownership. They know this is their money, and can take pride in nurturing it and watching it grow.
6. Real-life teaching tool
The adult trustee in charge of managing the informal trust can use it as a teaching tool for the child. Since the child knows this is their money, they’ll likely have more interest in learning how to invest and grow it.
Part 3: The downsides of informal trusts
As wonderful as informal trusts are, there are a couple of potential downsides to keep in mind:
1. Lack of control
There are different takes on this issue. Most info on the internet has this to say about informal trusts:
Unlike a formal trust, you have very little control over what happens when the beneficiary reaches the age of majority. At that point, they’ll legally be allowed to access the trust’s assets, which means they could have free rein with the money.
You can’t delay the child’s access to an older age, control how much they withdraw or stipulate how they’ll spend the money. If they want to withdraw it all and spend it on a sports car, you’ll have no recourse!
Now, here’s Ed’s take on this issue:
“The trustee controls the account, even after the child turns 18. The account is in their name, so the investment firm needs the trustee to sign transactions.
Technically, the child can demand the money, but in practice, they can’t get it without the trustee’s signature. This is important because the parents can effectively control the account until the child is mature enough to handle it.”
– Ed Rempel
Personally, I trust Ed’s advice 100% here. Based on how my kids’ ITF accounts are structured, I can see that we are joint holders of the account with each child. I also see that it clearly states that we are the trustees.
I believe that all financial institutions would follow similar protocols with their informal trusts and require that trustees sign off on transactions. So, based on what Ed’s shared, there should be no worries when the beneficiary of an informal trust reaches the age of majority.
See the “Logistics” section for more ideas on how to prevent a beneficiary from withdrawing funds from their informal trust.
2. They’re irrevocable
Once again, there are different takes on this issue. Here’s what many articles say about the irrevocability of informal trusts:
Informal trusts are irrevocable, which means you cannot change your mind and close the trust once it’s open. In addition, all assets deposited into the informal trust become the permanent property of the beneficiary (no one can revoke or take them back).
Once deposited into the account, the assets may only be used for the benefit of the beneficiary. You cannot withdraw the funds for your or any other individual’s use. Given this, be sure you or the contributor are prepared to give the assets to the beneficiary permanently.
Now, here’s Ed’s take on the irrevocability of informal trusts, which is rather different:
“There are lots of disclaimers in articles that worry people unnecessarily, saying that the money in an ITF account belongs to the kids. Parents cannot take it, and if they do, all the income since the beginning is taxable to the parents. This is usually not true:
The money should be used for the benefit of the kids, but parents have spent a ton of money over the years for the benefit of the kids. If parents withdraw it and are audited, they usually would have no trouble proving to CRA they spent that much for the benefit of the kids.
Legally, the money belongs to the kids. If parents change their minds and keep it, the legal issue is that technically the kids can sue the parents for the money. In practice, a lawyer I discussed this with says the truth is this has never been tested in court. No kid has ever sued their parents over withholding money in an ITF account (to his knowledge).”
– Ed Rempel
Again, I trust Ed’s advice, given his extensive and long-term experience with informal trusts. However, consult your own experts to confirm this is true, based on your situation.
Part 4: The logistics of informal trusts
Q: Who can open an informal trust?
Usually, it’s a related adult (parent, grandparent, aunt or uncle), but any adult can open an informal trust account for a child. The person who opens the informal trust can be the contributor, trustee, or both.
Q: How do you open an informal trust?
In my experience, informal trusts are opened the same way you would open a non-registered investment account for an adult. The form(s) may be slightly different or have a few extra fields, but the overall process is the same.
Each bank or brokerage will do things differently, but opening an informal trust is generally straightforward.
Q: Which banks and brokerages offer informal trusts?
I’ve held informal trust accounts at Scotia iTrade, Questrade, Laurentian Bank, and Fidelity Clearing Canada.
In my research for this post, I came across PDFs, articles and application forms for informal trusts from a wide array of Canadian financial institutions.
So, I think the better question would be, “Are there any banks or brokerages which don’t offer informal trusts?” And my answer would be, “Probably not!”
That said, I wasn’t able to research every single bank and brokerage, so give your financial institution a call to see if they offer informal trust accounts.
Q: Who controls the informal trust?
When the child is a minor, the trustee has complete legal control of the informal trust. That means they can do what they wish with the trust and the investments in it. (As long as it benefits the beneficiary and no one else.)
Once the child reaches the age of majority, they and the trustee share control of the trust. The child is legally entitled to the assets at that point, but they must have sign-off from the trustee(s) to initiate any transactions.
Q: Who owns the informal trust?
When a beneficiary is named in an informal trust, they become the legal owner of the assets in the trust. In addition, once a beneficiary is named, it is irrevocable. In other words, it’s irreversible and cannot be revoked or changed.
Q: Can the settlor also be the trustee?
A ‘settlor’ is the person who creates or ‘settles’ a trust. However, this term is typically only used when referring to formal trusts.
With informal trusts, there isn’t a term for the person who opens the account. That person could be the ‘contributor’, ‘donor’ and/or the ‘trustee’ and may be a parent, grandparent, aunt, uncle, cousin, family friend, or even a stranger.
Based on my research, informal trusts do not have settlors, nor does it really matter who opens the account. What does matter, though, is the following:
- The trustee(s) are named.
- The beneficiary is named.
- The contributor/donor understands that their gift to the minor child is irrevocable once it’s deposited into the informal trust. (There may be some flexibility here—see Ed’s take on this.)
- The contributor/donor understands that they have no legal control over the account or how the money is invested unless they are also the trustee.
Q: How do you ensure that an informal trust is valid?
There’s a lot of confusing info out there about this topic. Many articles warn parents and grandparents to be careful about opening informal trusts because they may not be recognized as trusts.
Even so, the authors don’t outright state that informal trusts should be avoided or that they never work as intended. (In my opinion, that’s because they usually do work just fine!)
Still, I’m no expert, so I would suggest that you get well-acquainted with the issue and make the best decision in your situation. Here are some articles that highlight the potential problems:
1) You must attempt to establish the informal trust as an actual trust: Informal or “In-trust” accounts—Friend or Foe (BMO Private Wealth)
2) How to properly set up an informal trust: Informal trust accounts: How they do and don’t work (Carol Bezaire at Advisor’s Edge)
3) Treat the informal trust as an ‘agency agreement’ instead: How in-trust accounts for your children are taxed (Tim Cestnick for The Globe and Mail)
It’s a scary issue… or is it?
This issue is, for me, the scariest part of informal trusts. Who would want to open one when there could be troublesome tax consequences down the road? Well, Ed has been using informal trusts for 25 years and has this to say about the lack of formality with informal trusts:
“Informal trust rules sound difficult because they are trusts, which are complex. No matter how unlikely, there is always a tendency to put in all the disclaimers and potential things that could go wrong. This worries people unnecessarily.
ITF accounts are informal trusts. They are a trust but without the formal agreement. An ‘agency agreement’ is a very general term for types of agreements where one person has a fiduciary duty for another—mostly for people selling someone else’s products. They are valid because they are informal trusts.”
– Ed Rempel
I feel comfortable with informal trusts because I have the benefit of working with experienced professionals. You may feel differently if you’re DIYing. The best you can do is get informed, consult your expert(s) and decide if you’re comfortable using informal trusts, despite their ‘risks’.
Q: What records do I need to keep?
If you keep the informal trust simple (as we do for our kids) and deposit all the money as if it all came from the same contributor/trustee, these are the records you’ll need to keep:
- T5s (report on the contributor or trustee’s tax return every year).
- T3s (report on the child’s returns, assuming they are for capital gains).
If you have an informal trust which only holds assets that are fully attributable to the beneficiary*, these are the records you should keep:
- T5s (report on the child’s returns, assuming they are for capital gains).
- T3s (report on the child’s returns, assuming they are for capital gains).
- Statements that show the income* received by the beneficiary.
- Informal trust account statements which show the above funds being deposited.
*Assets/income that CRA deems fully attributable to the beneficiary include: Canada Child Benefit payments, inheritances, T4 income earned by the child, and second-generation income.
Q: Does the contributor/donor need to be different from the trustee?
Some articles suggest that it’s best if the contributor/donor is not the same person as the trustee. Here’s what Ed has to say on this issue:
“No, not for informal trusts. We consider it as the trustee received a gift and then contributed it. Formal trusts usually have three parties: a settlor who puts the money in, a trustee who is responsible for it, and the beneficiary.
In the case of informal trusts, the trustee is usually both the settlor and the trustee. It is not really an issue with informal trust accounts.
If a third party contributes money to an account, there could be a potential issue with the anti-money laundering rules in securities. That third party is supposed to be vetted by the securities firm. That’s why we consider that the trustee contributed it.”
– Ed Rempel
Q: Can the informal trust be rolled into a TFSA?
Yes, absolutely! But how much can be rolled over will be limited by the beneficiary’s contribution room. Here’s how it would work:
- Open the TFSA when the beneficiary turns 18.
- Sell investments in the informal trust or transfer them in-kind to the TFSA. (Be careful not to over-contribute. This may be tricky when transferring a volatile investment in-kind.)
- The beneficiary would need to report the capital gains on their tax return for that year. (Even if transferring in-kind—use the book value and FMV on the date of transfer to calculate the capital gains.)
- Repeat every year, as-desired, or until all assets from the informal trust have been rolled into the TFSA.
There may be a few extra steps when transferring to the child’s account(s) one day. A reader by the name of John left this detailed comment:
Our in-trust funds are with TD and I am told we cannot simply transfer in-kind from these in-trust accounts to our children’s accounts.
First, our children have to set up an investment account and add us as secondary to the account.
We can then transfer the funds in-kind from the in-trust account to the shared account and then our children can move to their own TFSA/RRSP & trading account.
Once this is done, we can then close the in-trust account which will have a $0 value.
Q: Can the informal trust be rolled into an RRSP?
Yes, but it may not make sense to do this. That’s because the beneficiary must have earned income in order to have built the RRSP room. Since they can contribute their earned income to the RRSP pre-tax, using that money for contributions may make more sense.
Q: Can income from informal trusts create RRSP room?
Income and capital gains from investments are not considered earned income. Therefore, investments in an informal trust will not create RRSP room for the beneficiary.
Q: Are there penalties to withdraw from or transfer an informal trust?
No, just like regular non-registered accounts, there are no penalties on withdrawals. But there may be transaction or service fees—check with your bank or brokerage for details.
Q: How can you prevent the child from withdrawing all the money one day?
When the beneficiary reaches the age of majority, they are legally entitled to withdraw funds from their informal trust. However, Ed shares this info, which should help give parents peace of mind.
“The trustee controls the account, even after the kids turn 18. The account is in their name, so the investment firm needs the trustee to sign transactions.
Technically, the kids can demand the money, but in practice, they can’t get it without the trustee’s signature. This is important because the parents can effectively control the accounts until the kids are mature enough to handle it.”
– Ed Rempel
In case you want to be extra-careful, here are other ways to make it harder for the beneficiary to withdraw from their informal trust/ITF account:
- Set up a holding company and transfer assets from the informal trust into the holding company.
- Set up a formal trust, then sell the assets in the informal trust at FMV to the formal trust.
- Purchase a life insurance policy using funds in the informal trust.
These methods could protect informal trust money from an irresponsible child but they’re potentially messy and/or costly. I have a better, more effective solution—see the box below.
How to raise (or help raise) financially-responsible kids
To raise (or help raise) financially-responsible kids, I suggest that you focus on developing a trusting and healthy bond with the child and teach them how to care for, grow and respect their money. Here’s how and why:
Develop and maintain a strong bond
If the child looks to you as someone who genuinely cares for them and has their best interests at heart, they’ll very likely want to follow your advice and guidance.
This bond will also serve as a sort of insurance against irresponsible behaviour once they can access the money. They won’t want to disappoint you and will want to do their best with the money you helped them grow.
Teach and share
Throughout the child’s formative years, model good money habits and share your knowledge about money and investing. (And, if you want to get advanced, why not also teach them about FI—financial independence?)
This is how my husband and I, our siblings, and other family members grew up to be successful with our money. Not a single one of us has been reckless or anything less than responsible with our finances.
Part 5: Taxation of informal trusts
Alright, here’s the juiciest section! This is where we’ll dive into the most significant benefit of informal trusts—the tax advantages.
Q: How are informal trusts taxed?
The most unique feature of informal trusts is the way they’re taxed. The taxation differs, based on the source of the funds:
|1. Contributions are not attributable to the beneficiary||2. Contributions are 100% attributable to the beneficiary|
|Source of contributions:|
- Casual jobs.
|Source of contributions:
- Canada Child Benefit payments.
- T4 income earned by the child.
- Second-generation income.
- Taxed in the hands of the beneficiary.
- Taxed in the hands of the beneficiary.
|Income (interest and dividends):|
- Taxed in the hands of the contributor/trustee (when the beneficiary is a minor).
- Taxed in the hands of the beneficiary (when the beneficiary reaches the age of majority).
|Income (interest and dividends):
- Taxed in the hands of the beneficiary.
Let’s add some detail to that:
1. Contributions are not attributable to the beneficiary
Contributions that are not attributable to the beneficiary include income from gifts, casual jobs, allowance, etc. These forms of income are considered as being contributed by the trustee*.
In this situation, capital gains are taxed in the hands of the beneficiary and income is taxed in the hands of the contributor/trustee. (However, once the beneficiary reaches the age of majority, attribution ceases and all income is taxed in the hands of the beneficiary.)
*Even if the trustee is not the one who gave the money to the beneficiary, it’s best to attribute the contribution to the trustee. To learn why, see “Tips to avoid taxation headaches” in the box below.
2. Contributions are 100% attributable to the beneficiary
Contributions that are 100% attributable to the beneficiary include income from Canada Child Benefit payments, inheritances, T4 income earned by the child, and second-generation income.
These forms of income are 100% attributable to the beneficiary, so all income and capital gains are taxed in their hands from day one.
When it comes to informal trusts:
- Capital gains are always taxed in the hands of the beneficiary. (Yay!)
- Income is sometimes taxed in the hands of the contributor/trustee and sometimes taxed in the hands of the beneficiary.
Tips to avoid informal trust taxation headaches
If you’d like to achieve optimal taxation from an informal trust, be sure to read and understand these tips:
1. The trustee should also be the contributor
When investing money that is not attributable to the beneficiary (gifts, etc.), Ed says:
“If a third party (who is not the trustee) contributes money to the informal trust, there could be a potential issue with the anti-money laundering rules in securities. That third party is supposed to be vetted by the securities firm. That’s why we consider that the trustee received the gift, then contributed it.”
– Ed Rempel
That means, even if the gift originally came from grandma and grandpa, it’s still safer to treat the money as if the trustee is the one who contributed it.
2. Maintain separate accounts
If you’d like to invest contributions that are 100% attributable to the beneficiary (Canada Child Benefits, etc.) be sure to keep those funds in their own informal trust account.
You cannot commingle these contributions with other money (gifts, etc.), or the attribution rules will apply. This means the contributor/trustee will be on the hook for taxes on all the income.
Q. Do you have to file taxes yearly?
Yes and no. Yes, for the contributor/trustee, who must report and pay taxes on the income earned in the informal trust each year. No for the child, unless they are crystallizing capital gains.
Q. How can we minimize penalties or taxes?
Fortunately, there are no penalties for informal trusts. As for taxes, you can minimize them by:
- Investing for capital gains, not income (interest and dividends).
- Investing Canada Child Benefit payments, inheritances, T4 income earned by the child, and second-generation income in a separate informal trust so that all the income and capital gains will be taxed in the hands of the minor child.
- Crystallizing capital gains occasionally, when the minor child has little or no income. (For more details, see Ed’s tips in the box below.)
- If you’re the contributor/trustee who reports and pays taxes on the income from the informal trust, minimize your taxable income to keep yourself in a lower tax bracket.
Ed’s tips to minimize tax on capital gains
“ITF accounts can usually grow tax-free with a bit of tax planning. The strategy is to invest for capital gains so that all the income is taxed to the kids. Then, when the account has grown by $10–20,000, you can ‘crystallize’ the capital gain by selling the investments and buying them back.
This triggers $5–10,000 of taxable capital gain to the kids, which costs zero in tax. Each child gets the basic tax exemption of $13,000/year, and you can crystallize up to $26,000/year of capital gains for each child each year with no tax.
Many parents make the mistake of allowing the investments to grow for many years until the kids are adults and have other income before selling and claiming a larger capital gain on top of their other income.”
Q. Will the tax forms be issued in my child’s name?
When you open the informal trust, you will be asked to provide the contributor or trustee’s SIN so that T5s will be issued in their name. You will also be asked to provide the beneficiary’s SIN so that T3s will be issued in their name.
When this isn’t the case
Reader Max commented below that his brokerage, Scotia iTrade, issues all the tax slips under “Trustee ITF Beneficiary”. In other words, they don’t differentiate between the trustee and beneficiary—all the slips go to him, the trustee.
I also saw on Reddit that someone else had this same issue at Questrade. This is a worrisome problem that could scare many people away from opening an informal trust. And, unfortuntely, the information on this problem is very much lacking on the internet and from CRA.
So, once again, I turned to Ed to share his thoughts and experience in dealing with CRA and incorrect informal trust tax slip attribution:
Ed’s comments on informal trust tax slips
“The account names must be in the name of the trustee, since minors cannot legally own investments. The tax slips, mostly T5s, are always issued in the name of the account holder, which is the trustee. The same is true of notices of capital gains from investments sold during the year. Financial institutions mostly don’t understand ITFs or do it right, but fortunately, CRA usually understands (but not always).
We try to put the kids’ SIN numbers on the accounts, even though it is not in their name, but most financial institutions have trouble doing it.
The important thing is to just record them correctly on the tax returns. If it is capital gains, just record it on the kids’ tax returns. If that is their only income and there is no tax owing, you don’t have to file those T5s at all.
Occasionally, CRA notices that the parents have a T5 in their name that is not on their tax return and issues an inquiry or a reassessment. We then refile the tax returns with a note saying the T5 is an ITF and is taxed to the child. CRA usually accepts that on the first try, but sometimes takes several tries.
It can be a bit confusing, because the T5 slips often have a mix of income, such as capital gains, dividends and interest on the same slip. The slip needs to be fully recorded on one person’s tax return anyway. If it is mainly capital gains, we consider the entire slip to be taxable to the child. If it is mostly dividends & interest, we put it on the parents’ return.
CRA and the financial institutions do not know about how much of an ITF account is from the Canada Child Benefit or from a gift. The T5 slips come out the same way. This can be part of your reason for recording the T5 slip on the child, if CRA asks.”
Q. Can birthday, holiday or other gift money be contributed in the child’s name?
No, since it could be flagged as money laundering and is hard to track formally. It’s better to handle the child’s gift money this way: consider it a gift to the trustee, who then contributes it to the informal trust. Then, follow the usual attribution rules (income taxed to contributor/trustee; capital gains taxed to beneficiary).
Q. Can money earned from casual jobs be contributed in the child’s name?
This includes income earned by the child for things like babysitting, pet sitting, a lemonade stand, etc.
My answer: maybe, but it’s likely not much money and not worth the hassle and the risk of CRA disallowing the attribution to the child. I would stick to having the trustee contribute this money then follow the usual attribution rules.
For larger amounts
Some entrepreneurial kids (particularly teenagers) may earn quite a bit from casual jobs such as lawn mowing, home maintenance, or tutoring. In cases like these, you may want to consider carefully tracking this income so that the child can invest it in an informal trust 100% under their name.
However, tread carefully here. Consult your experts and/or CRA to determine what is required as proof of this income and where it came from. (This post from a babysitting website may be helpful as an overview of how to report income from casual jobs.)
Even so, do the math to decide if this is even worth doing. Remember: capital gains are essentially tax-free, since they’re taxed in the hands of the child. If you’re investing for growth and not income (as you should be, to minimize taxes), income should also be minimal.
For example, a 2% yield on $10,000 earned from a year of tutoring would result in $200 of income. If this was taxed to the contributor/trustee at the highest marginal tax rate of around 48%, that would result in $96 of tax.
Consider if it’s worth your time to maintain investments and records for a second informal trust account, just to save $96 per year in tax.
Part 6: Estate planning for informal trusts
If you’re the trustee of an informal trust, you should think about what you need to do for proper estate planning. Below, I’ve outlined what happens when the various people involved in an informal trust pass away.
Q. What happens if the contributor passes away?
According to this post: “If the contributor dies while the ITF account is in place, attribution ceases, and all investment income earned in the account is taxed in the beneficiary’s hands.”
If the contributor was also the trustee, see the next question.
Q. What happens if the trustee passes away?
According to this post: “If the trustee dies, the trustee’s executor will look to the trustee’s will to see if a replacement trustee has been named. If not, the account could remain in the estate’s name until the beneficiary reaches the age of majority.“
Ed also has this to add:
“The ITF account (aka informal trust) is legally the trustee’s, held jointly with the minor child. The trustee’s will will determine what happens with the account. The executor for the trustee’s estate should clearly be able to see that the account is intended for the beneficiary.”
– Ed Rempel
Q. What happens if the beneficiary passes away?
According to this post: “If the beneficiary dies, the assets in the ITF account will be distributed under the provincial and territorial rules of intestacy because minors in most jurisdictions aren’t legally entitled to draw a will.“
Ed also has this to add:
“If the child died, we would sell the funds and buy them back to trigger the gains so that we could claim them for them. In general, capital gains up until then are theirs and after that are yours.
Technically, anytime someone dies, all their investments are considered sold. So it may be possible to claim them on the child’s final return even if we didn’t get to selling the investments. However, it is always simpler to actually sell them so that we have investment company paperwork to support what we enter on the tax returns.
The cost basis for calculating the final capital gains would be the book value on death. Book value is tracked separately and is shown on the statements.
The account would then still be in the trustee’s name, and the trustee can take the money back or change the beneficiary.”
– Ed Rempel
Don’t procrastinate on estate planning
I’m passionate about estate planning. (I even included a lesson on it in my FI School series.) That’s because the consequences could be highly undesirable and very costly if proper plans are not put in place. Don’t procrastinate on estate planning—your loved ones will thank you!
Part 7: My additional thoughts on informal trusts
1. Next-level optimizations may not be worth it
I’m one of those crazy people who loves to optimize their money to the max! Even so, I still draw a line sometimes. Next-level optimizations for my kids’ informal trust accounts is one area I’ve decided to let things go.
What do I mean by next-level optimizations?
It’s these perfectly-legal but inconvenient tactics:
- Investing my kids’ Canada Child Benefit payments in a separate informal trust account.
- Investing my kids’ second-generation income (income earned from the original income) in a separate informal trust account.
Why do I draw the line on these optimizations?
- I did the math, and the tax savings would be negligible.
- The more finagling you do (even if it’s legal), the higher the chances you’ll be scrutinized by CRA. (Who wants more attention from CRA? Not me!)
- The recordkeeping would be onerous.
When I’d make an exception
If my kids received a large inheritance, I would open a separate informal trust account to invest that money. Then, it wouldn’t be much extra effort to also invest their Canada Child Benefit payments and second-generation income in that same account.
2. RESPs should be prioritized first
As much as I love informal trusts, I still think it’s best to prioritize contributing to RESPs first. Here’s why:
The ROI on RESPs is very high
The government grants you receive for RESP contributions are a guaranteed 20% return on your investment. (The child can receive up to $500 for the first $2,500 contributed per year.) Where else can you get that kind of return—guaranteed? Almost nowhere!
In addition, if the child’s family is low income, they may qualify for the Canada Learning Bond, which is even more free money from the government. Finally, some provinces also offer their own RESP grants (e.g. the $1,200 BCTESG from the Government of British Columbia).
That’s a lot of free government money that’s only accessible through RESPs.
RESPs aren’t as inflexible as most believe
RESPs have a reputation for being difficult to use, but that’s not entirely accurate. In reality:
- All contributions can be withdrawn tax-free.
- The grants and growth can be spent on anything related to your child’s education (tuition, books, rent, equipment, office furniture, transportation, meals, etc.)
- You don’t need to show receipts for these purchases. All you need is proof of the child’s registration in a qualified post-secondary program.
- Up to $50,000 of the unused growth may be rolled into an RRSP.
- RESPs can stay open for up to 35 years. In that time, the child may decide to go back to school, or the funds can be transferred to a sibling.
RESPs are tax-sheltered
Income earned in RESPs is not attributable to the contributor and remains tax-sheltered until it’s withdrawn. In addition, at withdrawal time, the income will be taxed in the child’s hands—which usually results in little or no tax.
On the other hand, income from informal trusts is attributable to the contributor/trustee until the child is of legal age. The contributor/trustee must report this income on their taxes every year. This could lead to more taxes paid overall than if the money was solely invested in an RESP.
If there’s a special child in your life who has extra money to invest, I would highly suggest opening an informal trust for them. These accounts (also known as ITF or in-trust-for accounts) are a simple, low-cost and tax-efficient way to save for a child’s future.
Informal trusts offer valuable tax advantages and lots of flexibility. They also serve the important purpose of teaching a child how to invest and grow their own money. There are some downsides and estate planning issues to consider, but overall, the benefits outweigh the issues.
I hope this post was helpful to you. Please feel free to comment below with your questions—I’ll do my best to answer them. (Also, be sure to read through the comment section! There are lots of great questions and answers from other readers that you may find helpful.)
I’d like to thank Ed once again for sharing his invaluable experience and expertise with me and my readers. I couldn’t have written this post without his help (including all the time he spent reading and checking my post for errors)!
If you’d like more from Ed, or to reach out to him, visit him on his blog, Unconventional Wisdom. You can also listen to Ed on my podcast, Explore FI Canada:
I’d also like to thank my friend, Jolie Viguers for inviting me to do an AMA with her Canadian Ladies Money Club Facebook group. (If not for this event, I wouldn’t have finally mustered up the motivation to write this long and challenging post!)
To get in touch with Jolie, you can join her Facebook group or find her at Well Bean Coaching. You can also listen to Jolie on my podcast, Explore FI Canada:
Max (reader and commenter)
Finally, I’d like to send a very special thank you to reader Max for being such an engaged commenter. I’m so grateful to you for sharing your experience with informal trusts. You’re a wealth of knowledge and have helped to fill in the gaps in the info I’ve shared. Thank you!
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