Money Management Newsletter: RESP
- Education Savings
Monetary gifts to grandchildren can create
"Well meaning grandparents often make investments
in their grandchildren's names to provide a future nest egg or to help
defray the expected high costs of a College or University education."
education plans are sometimes used for the latter purpose but these have
some restrictions and the possibility of forfeiture of any income earned
if the funds are not used for educational purposes at a recognized institution.
Many grandparents therefore simply establish a bank account in the grandchild's
name or buy them a GIC
Regular purchases of GICs or CSBs for the child over a long period of
time together with compound
interest can result in a substantial sum. This is great for the child
but what many people do not realize, is the large tax liability they may
create for themselves if the income on the investments is not properly
What are the income tax rules?
The income tax rules that apply are called income
rules, and pertain to blood-related minor children. The blood-related
definition includes children, grandchildren, great grandchildren and nieces
and nephews. A minor in this case is a child still under 18 years of age
at the end of the year.
The basic attribution rules for
blood-related minors are:
1) All interest,
and foreign income, earned on the principal amount invested is taxable
in the hands of the person gifting the money (unless the gift giver is
a non-resident). This is often referred to as primary or first generation
2) Future income earned on the first
generation income is taxable in the hands of the child. This is called
secondary or second generation income.
3) All capital
gains earned on the investments are taxable in the hands of the child.
4) Income from investments funded
exclusively from the child tax benefit or an inheritance is taxable in
the hands of the child.
5) It is the gift givers responsibility
to keep accurate records.
How can these rules affect you?
If you buy a single $5,000.00 GIC or CSB for a newborn
grandchild that earns 7% each year for the 18 years he or she is a minor,
the first generation income is $350.00/year (7% of $5,000.00) for a total
of $6,300.00 for the full 18 years.
The $350.00 is taxable in your hands each year and must be reported on
your tax return.
Any future interest earned on the yearly $350.00 (second generation income)
will be taxable in the child's hands.
If you do not keep proper accounting records, separating the first generation
income (taxable to you) from the second generation income (not taxable
to you), or if your gift money gets mixed in with money your children
put aside from the child tax benefit (not taxable to you), you can end
up with an accounting nightmare if Revenue Canada comes asking for clarification.
The more money that is involved and the longer the time frame without
tax paid by you the greater your chances are of having a significant tax
What can you do to protect yourself?
1) Keep very detailed records if you buy GICs or CSBs
for your grandchild.
2) Separate any interest earned on
the investment into a separate account so that future interest is documented
and taxed in your grandchild's hands.
3) Better still... consider using
an investment where the main source of income is capital gains (remember
capital gains are taxable in your grandchild's hands).
Since in most cases the investment will be long term, (up to 18 years),
consider using a growth mutual
fund where most of the return is in capital gains and long term performance
is often much better than GICs or CSBs.
Open the account in your name in trust for your grandchild to separate
it from your own money but still allowing you to control the investment.
Make sure a tax return is filed each year for your grandchild documenting
any capital gains or losses.
The important thing to remember is
that failing to properly report your tax liabilities can result in substantial
penalties if Revenue Canada decides to investigate. Not knowing the rules
is not a defense.
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