Use caution with in-trust accounts for children or grandchildren
When it comes to putting away money for your kids or grandkids, the financial industry is very quick to offer in-trust accounts as a viable option. The other options are either life insurance or Registered Education Savings Plans (RESPs).
An in-trust account is an informal trust so that an adult can invest funds on behalf of a minor. The account is set up in-trust because the child is under the age of majority and cannot enter into a legal binding contract. The adult is then responsible for investing for the child and signing the contract on behalf of the child.
Parents and other relatives often use in-trust accounts to save money for the child. One of the main benefits of in-trust accounts is the money can be used in the future for any purpose and not just for education — unlike an RESP which can only be used for education. Often the in-trust account is opened so the child can invest holiday or birthday money or the Child Tax Benefits.
In-trust accounts continue to grow in popularity mostly because they are easy to set up, have no legal costs to set up, and have no ongoing legal costs.
A time for caution
As much as in-trust accounts are easy and cheap to set up, remember the old saying that sometimes you get what you pay for.
In-trust accounts are often thought of as informal trust accounts. According to Marvin Toy, Co-author of Smart Tips for Estate Planning, “They are better described as incomplete, ineffective, and ill-advised. The problem is there is simply no such thing as an informal trust. Something is either a trust or it’s not. With a formal trust, there are very clear instructions on how the money is to be managed, when the beneficiary can access the funds, and how the assets are to be distributed. This clarity is very important to the usefulness of a trust. In-trust accounts have none of this clarity.”
Before you set up an in-trust account, you need to be aware of some very real potential problems.
- There is risk in using in-trust accounts because they may not be recognized in law without proper supporting documentation. As a result, it is imperative that the paperwork is completed properly
- Once you put money into an in-trust account, the money belongs to the beneficiary (child). This gift is permanent – there are no exceptions. The whole idea of a trust account is that the money belongs to someone who has rights to the money but is not given the authority to manage it. We’ve seen many instances where this fact is not understood. Some donors think they can take back the money whenever they need it. Legally, they cannot do so.
- In-trust accounts do a poor job of defining key things like how the money is to be managed, how long the trust is to continue, and how assets can be distributed to the beneficiary. There is lots of room for misinterpretation and even mismanagement, which will cause nothing but problems and potential conflict.
- When it comes to interest and dividend income, the tax on the income is attributed back to the donor. In other words, the donor has to report any interest or dividend income on their tax return. The only income that is not attributed back to the donor is capital gains.
- You can invest the Child Tax Benefit into in-trust accounts and have the child pay all the tax regardless of whether it is interest, dividend or capital gains income but only if the funds are solely from the Child Tax Benefit. You are better off setting up a separate account rather than co-mingle the funds with other sources. To take advantage of this relatively minor opportunity, you will need excellent record-keeping, or you could face reassessment by the tax authorities.
- The beneficiary (your child or grandchild) takes control of the funds at the age of majority, which is either 18 or 19 depending on the province you reside in. In other words, they can do whatever they want with the money. If they want to use the money in ways you don’t approve of, tough luck! The child can take legal action if you decline to give them access to the funds at the age of majority. With a formal trust, the donor defines the age of transfer and control.
- If the donor or the trustee dies before the child reaches the age of majority and there is no stipulation to engage a replacement trustee, the account could remain in the name of the estate until the beneficiary reaches the age of majority. We rarely see powers for replacement trustees put in place, which is very risky.
- If the child dies before he or she reaches the age of majority, the funds in the trust belong to the child’s estate. Because minors are not legally entitled to draft a Will, most minors will die without a Will and the child’s estate will be distributed according to provincial laws of intestacy. The donor cannot decide who gets the funds in an in-trust account if the beneficiary dies.
- Since there are no guidelines on how the funds inside an in-trust account should be managed, there is a significant responsibility on the shoulders of the trustee to manage the assets prudently. The problem is different people will have different definitions of prudent. If the child feels the funds were not managed properly, the child could take legal action against the trustee.
As you can see, there are a lot of potential problems with in-trust accounts. Mr Toy says “They are only good for causing confusion and legal disputes. There is never a good reason to have an account that is in-trust for another person.”
The information in this articles was taken from Jim’s book Smart Tips for Estate Planning. Jim is also the creator of My Estate Organizer, a tool to help people organize, diarize and share their estate information with the people they love. It is a tool designed to help beneficiaries and executors.
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Interesting reading, especially the conclusion. But… what if the child has disabilities and is not capable of money management when he/she reaches majority? Should one have to go through the complexities of a proper trust?
I believe its the Henson Trust for disabled children. Look the Henson Trust up and you should find out how it works.
Very good article. You don’t touch on the complexities involved when the parents or grandparents divorce and there are disputes about who controls the in trust accounts or one depositor wants to withdraw what they think is their share (it is not their share, it is the child’s).
Can you provide a list of what money from a trust can be used when the income that is passed down to the grandchildren… requires it to be spent ” for the benefit of the children” to maintain it being taxed in the under 18 years of age grandchildrens hands. For example, if my son wanted to renovate their basement to allow the children to have a play room…would this be allowable?
Certainly that becomes a little grey. Since the renovation is for the benefit of the entire family including the children, how much money can you take out of the grandchildren’s trust to pay for it?
As mentioned earlier, make sure you document everything very well and the reasoning behind it.
IF the entire renovation is for playroom, bathroom and bedrooms for the kids, I would think you could write off most of it. But your accountant would be best to advise you.
we want to set up a trust for coming soon estate proceeds for my sister’s adult children who are disabled. I am executor and will be the trustee. Some proceeds come from RSP and life insurance. Can we do an informal trust? Will earnings be taxed to beneficiaries?
Great article Jim and Thanks. In my case I am a co-executor. Testator wanted money controlled by the executor(s) for grandchildren under 25 and by a guardian/parent if under 18. We are thinking of setting up the simple in trust accounts in the name of the parent(s) with a signed letter assuring us that the money will be used for valid care, education etc. Wondering of those over 18 but under 25 could withdraw the money without the parent. Sounds like only a formal trust will accomplish that. We do not want further involvement or tax attribution to ourselves.
My son is 15 and is incredibly bright. He wants to invest in the stock market and plan for his future. He’s been a great saver and has a good starting fund. I’ve looked into in-trust accounts, but it seems that there are lots of problems with them that might result in taxes to me. I’m not too worried about dividends or interest, but I’m hoping he’ll see some decent capital gains that I wouldn’t want him to lose to income tax under attribution rules.
I’ve lots of TFSA room, so I’m wondering if I should open a TFSA account and put the money in there. Then I can invest according to his instructions and when he is 18 I would transfer the securities to a TFSA in his name.
Is this something that can work? I understand that there will be issues if I die before he turns 18, but all income for the 2.5 years he has to wait would be tax free. And I would get the TFSA room back the following year.
How would my kids get taxed when they turn 18 if the in-fund account holds only index fund units or shares? Would they get taxed on the total amount in the account at 18 or only when they sell units and realize capital gains?