What you need to know
Parents and other family members often want to help kids make a successful jump into adulthood with funds for post-secondary education or other “launching costs” such as home down payments. In-Trust-For Accounts (ITFs) can offer a secure, tax-efficient way to grow wealth dedicated to the future of children.
Here is how they work.
What are ITFs?
In-trust-for accounts are required for investments held for anyone under the age of majority (18 years in Ontario) because children and youth are not legally permitted to open accounts in their own names.
ITFs are also known as “informal trusts” because no formal trust deed or indenture is created when accounts are established.
Opening an ITF can be as easy as selecting a check-box on an account application. ITFs are also very flexible investment structures because they do not typically require you to determine any additional details on how the income or assets of the trust will ultimately be provided to their beneficiaries.
A few basics
Like other trusts, ITFs are irrevocable, which means they cannot be modified or terminated without the permission of the beneficiary.
When assets are added into an ITF, they are gifted at that time and legally become property of the beneficiary. As such, the contributor cannot take back the contribution for their own purposes. (However, withdrawals from an ITF to benefit the beneficiary are generally allowed and do not cause legal concerns.)
Upon reaching the age of majority, the beneficiary has the legal right to access the entire account and use it in any way they choose.
Things to consider
- Open one ITF account per child. In most circumstances, they will reach age of majority at different times, and this has tax implications.
- Do not put any funds or assets into an ITF account that you wouldn’t ordinarily be willing to part with.
- Open separate accounts for funds from multiple sources. Avoid complicated accounting due to co-mingling funds that fall outside of attribution with other contributed assets.
- ITFs are a great opportunity to educate youth on being good stewards of wealth. Make them aware of the accounts early on and help them see the true value of the gift.
The Income Tax Act applies “attribution rules” to income earned within the ITF investment portfolio for youth under the age of majority:
- Interest and dividends are typically taxed to the contributor.
- Capital gains (upon distribution or disposition) are taxed to the beneficiary.
There are a few strategies that contributors can use to avoid tax attribution on interest or dividends. For example, open the ITF account using the regular deposits from the Canada Child Benefit. These funds are already marked for the benefit of the child, so CRA does not include them under the attribution rules.
The attribution rules apply only to “first-generation” interest, income or dividends. If these are re-invested within the same ITF account, they may accrue further interest, income or dividends, which are then considered “second-generation” money. The catch here is that second-generation money does not fall under attribution rules, so they could be taxed to the beneficiary (not the contributor, like first-generation funds). This can become quite complicated to manage and track. You can get around this by re-investing the income that’s generated either into a separate ITF account or a different investment holding contained in the same ITF account.
Once the beneficiaries reach the age of majority, the accounts should be moved into their names exclusively. If not, tax issues can arise; interest, income and dividends will still be taxed on the contributors’ tax returns, which in all likelihood will have a higher tax rate than the beneficiaries. This transfer into the beneficiary’s hands is tax free—it does not trigger any capital gains tax because beneficial ownership does not change.
The Trustee’s role
Like a formal trust, the trustee assigned to an ITF has a fiduciary duty to the beneficiary, which can include making the beneficiary aware of the funds available to them when they reach the age of majority.
If the trustee does not keep beneficiaries aware of the funds they’re entitled to, the beneficiary can pursue legal action against the trustee for any damages that result from not releasing the funds.