A few weeks ago, I wrote on the unique position grandparents are in to help pass on financial literacy to their grandchildren. This got me thinking a bit more about wealth transfers in general and what else these grandparents might be passing on.
While most people like to keep control of all of their wealth until they pass on, there may be a strong argument for gifting some of this money on while you're still alive - especially if you're sure you won't need it all in your lifetime and plan to pass it anyways.
Most wealthy Canadians have already maxed out their own RRSP and TFSA contribution room and the bulk of their investment assets sit outside of registered plans where they are subject to higher taxation. If this money is earmarked to pass on to heirs down the road, why not pass it on now and let it grow more quickly while reducing your tax bill at the same time?
Unlike in the U.S., Canadians are able to gift any amount of money to their children and grandchildren (although you do need to be aware of attribution rules).
There are some potential pitfalls that can occur when gifting to minors, so for a simple example today I'm going to look at an 18-year-old grandchild.
Young adults today often struggle to save as they face the costs of post-secondary education, launching their careers and starting families of their own. If they lack the cash to start making significant RRSP and TFSA contributions in these early years, their unused contribution room simply piles up. By taking advantage of these tax advantaged accounts earlier, the power of compounding can really add up.
The average return of stock markets of all developed nations over the past 112 years is 8.5 per cent. The average return since 1970 of the Canadian and US markets show figures of 9.1 per cent and 10.6 per cent respectively. So for this example of long-term growth, I've decided to use an eight per cent growth rate.
Let's say the grandparent helps this 18-year-old grandchild open a TFSA and gifts the $5,500 maximum contribution amount each year. When they reach age 30, this grandchild would have $112,724 in their TFSA account with total contributions of only $66,000.
Second, let's assume the grandparent puts the $5,500 contribution in for 20 years and then passes away. There are no further amounts deposited into the account until the grandchild reaches age 65 and decides to retire.
Based on the same 8 per cent growth rate and a total of $110,000 of contributions, the account value would have grown to $2,171,363.
Stretching this out further, let's assume the grandparent stops contributing after 20 years, but the grandchild takes over the contributions - at age 38, we hope they're financially stable and able to do so. When this grandchild reaches age 65, their TFSA account is now with a staggering $2,690,226.
This would result in a further $518,863 of account value with only $148,500 of extra contributions. Furthermore, they could withdraw the entire $2.69 million without owing a penny in taxes.
I realize not everyone is in the position to gift $5,500 each year to their grandchildren, but if you are in the position to gift even 10 per cent of this amount, or $550 per year, that would still provide a tax-free nest egg of $269,000 with the above example.
This "giving while living" strategy can save significant taxation to the family group as a whole if done properly. It could also significantly increase the financial legacy you leave behind. Like all financial decisions, make sure you seek out properly qualified advice before deciding what's right for you.
Brett Millard is a certified financial planner and owner of SPEIR Wealth Management Inc. Email
or call 778-478-4277.