It’s never too early to invest for a child, and we have the tips for you to do it successfully
If children are under the age of 18, they cannot yet invest as adults. However, there are savings and investment options available for those who want to invest for a child, or for a grandchild.
Opening a bank account in the child’s name is a good starting point. Continue reading for other investing strategies to benefit children.
Informal in-trust accounts are good options to invest for a child
If you want to build up an investment portfolio for a child, then an informal in-trust account is a low-cost and flexible option. (Investments or investment accounts in the name of a child must be set up in trust because minors are not allowed to enter into binding financial contracts.) An adult must be responsible for providing the investment instructions and signing the contract on the child’s behalf.
An informal in-trust account has a donor (or “settlor”) who contributes funds to the trust. The trustee is the person in charge of the account, and is responsible for managing the funds for the child (the “beneficiary”). The settlor should not act as the trustee. The settlor’s spouse can be a trustee, however. The money belongs to the child, but only the trustee can make withdrawals if the child is under the age of 18. Once the child reaches 18, the money is theirs to do with as they wish.
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How to invest for a child: Rely on capital gains rather than dividends
Interest and dividend income earned in an in-trust account is attributed to the contributor until the child turns 18, unless the contributor is not related to the child. However, all realized capital gains are directly attributable to the child. So it’s best to downplay investments that mainly provide interest or dividends, and instead hold stocks or ETFs that will earn capital gains.
Exchange-traded funds are among the best options to invest for a child
Exchange-traded funds are some of the best investments to choose as a starting point when building an in-trust account. If you start out with exchange-traded funds, we recommend putting, roughly half of your contributions into a Canadian exchange-traded fund and the remaining half into an exchange-traded fund holding U.S. stocks. ETFs, with their relatively low management fees (MERs), have in large part eclipsed interest in mutual funds. As well, upcoming regulatory changes in Canada will force brokers to disclose all the costs associated with mutual funds and other similar investments. That should further increase the appeal of ETFs.
There’s nothing wrong with buying individual stocks in the child’s in-trust account with smaller sums, say, under $12,000. You just have to accept a bigger proportional commission expense when you get started. To further cut your commission costs, consider buying the shares through a discount broker, rather than a full-service broker. That’s because discounters generally charge much lower minimum commissions.
Registered education savings plans (RESPs) are one of the best ways to save for a child’s post-secondary education
There are no annual limits for contributions to RESPs. However, RESPs have a lifetime limit (from birth to age 17) per child of $50,000. Only the first $2,500 of contributions per year to RESPs will receive a Canada Education Savings Grant (CESG) from the federal government. Under the CESG, the government will match a portion of what you put in: for the first $500, the matching amount is dictated by your family income, and for the subsequent $2,000, the government will match at a rate of $0.20 for every dollar contributed. The net family income amounts are indexed to inflation each year.
Contributions to RESPs aren’t tax-deductible like RRSP contributions, but the money does grow on a tax-sheltered basis. When the student withdraws the plan’s earnings, they are taxable to the student, not the contributors. However, students usually have little income and pay little or no tax.
All income earned in RESPs—whether it is in the form of dividends, interest or capital gains—grows on a tax-sheltered basis with no attribution back to the contributor. Contributions and Canada Education Savings Grants (CESGs) from the federal government are not taxable when withdrawn for the student’s education.
What strategies have you used to invest for a child? How have these investments performed? Share your experience with us in the comments.
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