Investing for Children: RESP or In-Trust For Account?

Suppose parents or grandparents want to set aside money for a child. Or suppose a minor child (under age 18 or 19 depending on the province) receives a significant inheritance, or has part-time or summer job earnings that you think should be put away to grow, perhaps for higher education or an eventual house purchase.

The money will be safe in a bank account but not earning much. GICs are also safe but grow slowly. If the intended spending is many years away, investing is an attractive option but there is a problem - legal restrictions prevent minors from opening an investment account in their own name.

Two options may provide a solution. Both are typically available at discount brokerages. The new TFSA is not an option since only those 18 and over can have one in their name.

Registered Education Savings Plan (RESP)
This is a special plan created by the Government of Canada to assist savings for post-secondary education by allowing tax-free growth inside the plan and by providing extra grants, the Canada Education Savings Grant (CESG) for everyone and the Canada Learning Bond for lower income families (details at CanLearn.ca).

Informal Trust aka In-Trust For - (ITF) Account
In such an account, a parent or other adult acts as trustee to manage investments on behalf of the child, who becomes legally entitled to take over at the age of majority. In this type of account, there is no restriction for how or when the funds may be withdrawn and spent (Invesco Trimark describes the basics here).

There are many important differences between RESPs and ITFs in terms of control, ownership, flexibility, grant availability and especially taxation, some of the key ones of which are summarized in the chart below. RESPs and ITFs are essentially equal when it comes to investing itself as all types of stocks and bonds are allowed in both and in allowing virtually anyone to contribute.

Assuming that the possibility of further education is a goal and other things being equal, my take on how RESPs and ITFs shake out are this:

• it is worth contributing enough to the RESP to get the full government grant money, which means making contributions over a period of years, instead of all at once
• if there is enough money, put the max CESG amount in the RESP and the rest in an ITF
  
• to keep things simple, parent or grand-parent money should go into the RESP before it goes into the ITF
  
• put the child's own money into an ITF; in this case, the tax attribution complexity doesn't arise; there will be no taxes for the child to pay unless the sum to invest is very large and produces more than the basic personal tax-free allowance in income every year (e.g. in 2009 the personal allowance is $10,320, which is equivalent to 6% on $172,000)

Of course, things are never exactly equal or the same for every person, so it behooves readers to think carefully about the various factors before deciding what to do. Form-filling and trustee arrangements (separate persons to be trustee and contributor) in compliance with laws and regulations, especially with regard to the ITF option, is critical if the tax benefits are not to be denied by the Canada Revenue Agency. This blog post is not advice. It may well be worth getting proper accounting or legal advice.

More Background:

• Formalizing Informal Trusts by Teresa Gombita on CA Magazine
• Don't let trust accounts be a taxing issue by Arthur Drache at the Financial Post
• Comparing education savings options at Investored.ca