Financial Considerations For A Growing Family
When your family circle grows, there are financial implications. Whether it is due to the birth of a child or grandchild, the start of a common-law relationship, or celebrating a marriage, there may be opportunities and challenges that result.
Having A Child
Canadian families spend a lot of money on children. According to Statistics Canada data from 2023, it costs about $293,000 to raise a child from birth until age 171. This is an average of over $17,000 per year for a middle-income family with two parents. There can be a significant range depending on a family’s income.
The indirect cost of housing represents about one-quarter to one-third of those estimated expenses, so the direct costs are lower. Regardless, spending will continue to rise in the future with inflation, but this is a reasonable starting point to estimate the cost in today’s dollars.
To fund these expenses, you need financial assets, income, or both. Most people rely more on income than financial assets when they are young, with one key exception. Young people have an asset called human capital that represents their ability to earn income in the future through employment or self-employment.
This human capital asset is turned into income, but it has risks. In particular, the risks of disability or death. These risks can be mitigated using insurance. Given the cost of having a child, let alone the high cost of living in Canada, young parents may be tempted to leave insurance out of their monthly budget.
Life insurance is relatively inexpensive when you are young and healthy. Many group benefit plans for employees offer a base level of insurance, as well as the potential to add additional optional coverage with employee-paid premiums. But even if you need to buy additional coverage through a third-party insurer, the cost tends to be modest. The reason is because when you are young, you are not likely to die. So, the risk of death is often an easy risk to insure against.
Disability is a different story. Disability insurance can be purchased to replace your income if you become disabled. Payments to a disabled claimant are monthly, like a salary. Some policies pay you for up to 2 years, whereas others will continue until you are 65. Insurers may offer inflation-adjusted policies, so disability payments rise with the cost of living.
Someone who becomes disabled at 35 could have 30 years of payments if their policy provisions pay them until age 65. So, the benefits could be millions of dollars in some cases. Between this, and the higher likelihood of a young person becoming disabled than dying, the premiums for disability insurance tend to be relatively high. This can be a deterrent for a young parent, but a massive risk to go uninsured when a child, let alone your partner, relies on your income to pay for family expenses.
A Registered Education Savings Plan (RESP) is a great tool to save for the expense of a child’s future post-secondary education. Contributions are not tax deductible, but the RESP account grows tax-deferred. The government matches at least 20 per cent of contributions of up to $2,500 per year, plus up to $2,500 of missed contributions for previous years subject to lifetime limits. Additional government support may be available for low-income contributors.
The original contributions can be withdrawn tax-free. A withdrawal of government grants and investment growth is taxable but if the child is attending an eligible post-secondary program at the time, the income is taxable to the child and not the parent. The child generally pays little to no tax due to their low income as students.
Becoming A Grandparent
A grandparent can also open an RESP for a grandchild. However, a beneficiary may only receive a lifetime contribution limit of $50,000 regardless of the number of accounts2. Annual government grants are also based on the beneficiary, so having multiple accounts can lead to confusion about the eligibility of contributions for the 20 per cent match.
In some cases, it may be preferable for a grandparent to gift money to their child to contribute to a single RESP for a grandchild owned by that child. A grandparent can also save outside an RESP for a grandchild in an informal or formal trust account. There are tax and legal implications when doing so.
An informal trust account is an account you open that is meant for someone else and is not established using a formal trust deed from a lawyer. A grandparent can open an informal trust account, sometimes called an in-trust-for or ITF account, for a grandchild.
There has been considerable confusion in recent years about potential tax filing requirements for these accounts, but currently, accounts under $250,000 can be exempt from tax filings.
If the trustees (accountholders) and beneficiaries of an informal trust account are all individuals and related to each other, and the assets consist only of cash, Guaranteed Investment Certificates (GICs), bonds, stocks, Exchange-Traded Funds (ETFs), or mutual funds, an informal trust is generally exempt from filing a T3 trust tax return each year.
One drawback with an informal trust is that interest and dividends get taxed back to the grandparent. This is called “attribution”. The attribution rules apply to income, like interest and dividends, but not capital gains. So, capital gains can be taxable to a grandchild. And since a taxpayer can have roughly $30,000 of capital gains if they have no other income and pay no tax, depending on the province, most capital gains for informal trust accounts are tax-free and may not require a tax filing.
Another drawback of informal trust accounts is that when the grandchild attains the age of majority—18 or 19 depending on the province—the account belongs to them. So, there is a lack of control in the long run with an informal account.
A grandparent can also set up a formal trust account. This can be an inter vivos (during life) trust or a testamentary (on death) trust to leave money to a grandchild in your Will.
An inter vivos formal trust account has some benefits. If you loan the money to a formal trust at the Canada Revenue Agency (CRA) prescribed rate, currently 4 per cent, you can have interest and dividends, as well as capital gains, taxed to a grandchild. If you give the money to the trust instead of lending it, capital gains are taxable to the grandchild, and the interest and dividends can also be taxed to the grandchild once they are adults.
A formal trust also allows the control of the trustees to apply after the age of majority. It can provide detailed instructions about what happens if the grandparent becomes incapacitated or dies.
The cost and complexity of formal trust arrangements are drawbacks. There are legal and accounting fees payable both up-front and ongoing that could be thousands of dollars per year. So, a formal trust tends to be set up with hundreds of thousands or even millions of dollars as opposed to smaller amounts.
Regardless of a grandparent’s approach, helping your children indirectly by providing financial assistance to their children directly can be a great strategy for those who can afford it.
Common-Law Relationships And Marriage
Whether you get into a new relationship, or your children do, there can be impacts on a family’s finances.
There is no “right” way to combine finances. Some couples keep their finances very separate. They may agree that one will pay for certain expenses and the other for other expenses. They may maintain a joint bank account with deposits in equal or unequal amounts to pay for some or all of their expenses. Yet others combine their finances completely.
There can be opportunities ranging from coordinating benefits between employers or contributing to a higher-income spouse’s Registered Retirement Savings Plan (RRSP). Common-law or legally married spouses can also use a spousal RRSP where one spouse contributes using their RRSP room and deducts contributions on their tax return, but the account is in the other spouse’s name.
Family law is a provincial matter, so what happens when a couple splits can vary across the country. In some provinces, common-law spouses each keep what is in their names and have no division of property when they separate. Married spouses generally have a division of assets accumulated during marriage. Domestic agreements like “prenups” can be considered, but can be uncomfortable to discuss and prepare, or may not be fully enforceable.
Support obligations often apply when a common-law or married couple splits. These can include spousal support where there are income differentials, and child support when children are involved. Spousal support tends to be tied to the length of the relationship, whereas child support often lasts until a child finishes post-secondary studies.
When gifting or loaning money to your spouse or to a child who is in a relationship, tax and family law implications may result.
If you give money to your spouse or common-law partner to invest, the income—interest, dividends, and capital gains—are generally attributed back to you and taxed on your tax return. You can loan money at the CRA-prescribed rate, and they can report the income, less the interest expense, on their tax return.
You can give money to an adult child with no tax implications. If you give an asset to them, there will be a deemed disposition and potential capital gains tax for assets that have been appreciated. So, you cannot gift them stocks or real estate without triggering a capital gain. There is no workaround, like having them pay you a dollar or some amount below the fair market value either.
Some parents want to loan money to a child, especially if they are worried about that child’s relationship breaking down. In the case of an interest-free loan, any subsequent interest or dividends are taxable back to the parent. An interest-free loan or any loan that does not have commercial repayment terms may be difficult to enforce in the event a child has a relationship breakdown, so legal advice in the province of residence is important.
Summary
New additions to the family can be joyous events, whether by birth or marriage. There may be new financial opportunities as a result of those new family members, although tax, legal, and practical implications may apply as well.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
1 https://www.statcan.gc.ca/o1/en/plus/6254-so-you-want-have-baby
2 https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4092/registered-education-savings-plans-resps.html#P52_7449