Giving money to your grandchildren

Q: A senior couple would like to transfer shares in individual companies to five different grandchildren. All are under ten years old. Some are held through an advisor and some with a discount brokerage firm.

What are the pros and the cons?

Effect on capital gains?

Can the shares be held as right of survivor with grandparents and grandchild (pros and cons)?

Other thoughts or concerns?

– Kerry

A: I’m going to assume that you are an advisor or family member of this senior couple, Kerry. I’ll try to hit on all the pertinent points.

If one family member transfers capital assets like stocks to another family member, except for an inter-spousal transfer, the transaction is deemed to take place at fair market value. So, in this case, if grandparents transferred common shares to their grandchildren, it would be as if the grandparents sold the assets at the current market value.

This may result in a capital gain or a capital loss for the grandparents, depending on their initial purchase price (adjusted cost base).

Ask a Planner: Leave your question for Jason Heath »

Future growth in the shares would be taxable to the grandchildren, with the grandchild’s adjusted cost base for tax purposes being the fair market value at the time of transfer. However, future dividend income would be taxable to the grandparent. This concept is called attribution.

Attribution prevents certain family members from splitting income with certain other family members. In this case, the attribution rules would prevent a grandparent from splitting dividend income with their minor grandchildren until they were 18 years old. Any dividend income earned should be reported on the grandparent’s tax return. From age 18 onwards, both the capital gains and dividends would be taxable to only the grandchild.

Of note is that the grandchildren won’t be able to have an investment account on their own until they reach the age of majority for their province (18 or 19). So, in the event of a gift, the account will need to be established as an in-trust account (informal trust) or joint account.

You asked, Kerry, about owning the shares jointly with rights of survivorship with the grandchildren. The tax implications really depend on the intention of the grandparent. If the grandparent’s intention was to gift the entire account to the grandchild at the time the account was established, the same taxation as gifting the entire asset would apply. That is, the capital gain would be fully taxable to the grandparent, future capital gains would be taxable to the grandchild, and future dividends would be taxable to the grandparent until the minor attained the age of majority.

If the joint ownership is an estate strategy, to have the entire account go to the grandchild only upon the grandparent’s death, beneficial ownership remains with the grandparent until their death. That is, all capital gains and dividend income are still taxed to the grandparent and the account goes to the grandchild on the grandparent’s death. If the grandchild is still a minor at that time, they will need an adult, like their parents, to be on the account as well until they reach the age of majority.

If the grandparents decide to open joint accounts with their grandchildren, they should ensure that they document clearly their intention with the accounts. That said, Kerry, I’m not sure a joint account is the best option given the ambiguity and the lack of control on the grandparent’s death.

Additionally, upon the grandchild reaching the age of majority, they would have legal access to the account if it were an informal trust or a joint account.

These grandparents could consider using the shares to fund a Registered Education Savings Plan (RESP) for their grandchildren. They can contribute up to $50,000 per grandchild cumulatively, including any contributions their parents, other grandparents or other people have made to an RESP for that same beneficiary.

These grandparents could also consider establishing a formal trust. The formal trust could ensure better control of the investments, including after the grandchildren were no longer minors. A formal trust might cost up to $5,000 with a lawyer to establish. And annual tax returns could cost $500-$1,500 with an accountant. But if the trust is established with a loan from the grandparents at the Canada Revenue Agency prescribed interest rate (rising from 1% currently to 2% on April 1, 2018), the dividend income can be taxed to the grandchildren instead of the grandparents. A formal trust might only make sense if the sums involved were quite large.

I think the main thing for these grandparents to figure out, Kerry, is their intention. If they want to stop the accumulation of capital gains tax on their shares, a gift to their grandchildren will do it. As will a joint account where they document their intention to give up beneficial ownership to their grandchildren. A trust will do the same but may provide more control and the ability to split dividend income, albeit this comes at a cost (legal and accounting fees).

An RESP may be the simplest and cheapest way to hold assets for a minor grandchild and there are added benefits. Not only is the income not attributed back to the grandparent, it is tax-deferred. And up to $2,500 per year of contributions benefit from a 20% government grant. The account can also be easily transferred to a successor subscriber on death.

Ask a Planner: Leave your question for Jason Heath »

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.