Blog “In-Trust For” AccountsNovember 13, 2018
“In-Trust For” accounts (ITFs) are investment accounts that are generally opened at financial institutions for the benefit of other persons with no written trust document or agreement. These accounts are often opened up for the benefit of minor children or grandchildren, and usually start with small contributions. However, over time these contributions can grow to a healthy sum, possibly creating un-intended tax consequences.
ITFs are promoted as a tax efficient way to invest funds in your child or grandchild’s name, as the capital gains generated from the investment are believed to be taxable to the minor child, who has a much lower marginal tax rate. These funds are usually invested to generate capital gains, as other income distributions from the investments would be subject to the income attribution rules, and would be taxable to the parent/grandparent contributor.
The income splitting opportunity presented from an ITF account is the attraction for parents or grandparents looking to invest money for their children/grandchildren, however, it is important to understand the pitfalls these accounts can create.
With these types of arrangements, it is very important to make sure that a trust has actually been established. Where a trust has not been established, because of a lack of formal documentation, all income (including capital gains) from the ITF account will be taxed in the hands of the contributor.
Even if a trust is found to exist, many tax and legal issues may still arise. These issues include:
• When the beneficiary will be entitled to enforce distribution of his or her interest in the trust upon attaining the age of majority. This will be the case even if the child is not responsible enough to handle the funds from the trust.
• Where the contributor of the funds is also the sole trustee, which is most often the case with these structures, the Canadian tax system has certain rules that will attribute all income and capital gains to the contributor during the lifetime of the contributor, regardless of the age of the beneficiaries. Also, trust property can generally roll tax-free from the trust to a capital beneficiary, however, the attribution rules discussed above will make it so no rollover is available – creating tax consequences upon the distribution of capital from the trust.
• When Trusts have certain legal requirements that must be adhered to. While an ITF account may have been created without formality, the legal requirements pertaining to trusts and trustees still apply. These include the requirement to comply with provincial law regarding the prudent investor rule, the requirement to account to beneficiaries and pass accounts, and the obligation to prepare and file annual income tax returns. In addition, should the contributor or the trustee decide to use the trust property for their own benefit, and not for the benefit of the child/grandchild beneficiary, they will be in breach of trust.
• All income generated by the investments – that is not paid or payable to a beneficiary of the ITF account arrangement – will be taxed at the highest marginal tax rate in the trust, unless the income attribution rules discussed above apply. Thus, if the income generated by the investments is reinvested and not paid or payable to a beneficiary, it will attract the highest rate of tax applicable to individuals.
ITF accounts are promoted as a way to invest funds for your child or grandchild in a tax efficient way, without going through the expense of a formal trust arrangement. However, given the potential uncertainty, and the other tax and legal issues described above, the obvious conclusion should a trust be intended is to have a formal trust arrangement drafted.
Structured properly, a formal trust arrangement can be a very valuable tool to accumulate wealth for your children. Unfortunately, though, the simplicity of an ITF arrangement often becomes the over-riding reason for the setting up of such accounts.
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Authored by: Jason Nagel, Director of Advanced Planning at Three60 Wealth