Estates
Parents often consider providing financial assistance to their adult children during their lifetime, versus through their estate. The potential benefits of a living gift may be two-fold; parents get to directly witness the benefits of their assistance to their children, and their children benefit from being on a more solid financial footing (possibly by reducing their debt load or increasing their savings towards their own future goals).
Gifting to children is not without its pitfalls, however; therefore, careful consideration must be given to all forms of planned gifts. Here are questions you’ll want to consider:
- Can you afford to gift?
- Is it a gift or a loan?
- What happens to the gift in the event of a breakdown in your child’s marriage or common-law relationship?
- What are the effects on your children's motivation to succeed?
- Can you/should you gift equally?
- What are the tax implications of living gifts?
Can you afford to gift?
Have you tested your financial plan to ensure that once funds are gifted, your household still has enough to meet your lifestyle needs, plus extra contingency funds in case of unplanned spending needs or market downturns? You are recommended to meet with your advisor to review the impact of an immediate gift on your own financial projections, before taking action.
Ensure your analysis includes not only the gift, but the potential tax liabilities that may be incurred by your household as a result of the gift. Tax implications are discussed in further detail below.
Is it a gift or a loan?
When considering the gift and the intended use or outcome of the gift, ask yourself a question; Are these funds a gift, or a loan?
For gifts, there should be clear documentation of your intention to gift the funds to your child. If you are gifting unequally to children or grandchildren, it is recommended to clearly outline your rationale. See 'Can you/should you gift equally?' below for more information on this topic.
For loans, documentation such as a loan agreement should clearly identify the borrower(s) and lender(s) and set out the repayment terms. Are you taking collateral to secure the loan? What recourse can you/will you take in the event of default by your child? How much interest will you charge, if any?
Loans also have their own tax implications to consider. If your child is paying you interest on the loan, that amount would normally be taxable to you. However, that interest is only tax-deductible for your child if they use the loaned funds in certain ways, such as for the purpose of earning income from investments. You should ensure your tax advisors have considered both sides of the loan.
In consideration of your estate plan; are any gifts intended to be counted as an advance against that child's entitlement under your estate? In the case of a loan, will the debt be forgiven on your death, or remain owing to your estate? These are considerations to discuss with your estate planning lawyer to ensure your intentions are clearly documented and accounted for in your will.
What happens to the gift in the event of a breakdown in your child’s marriage or common-law relationship?
Each province has its own rules for the division of property and it is usually your child's province of residence that will determine the applicable legislation. In Alberta, when property is expressly and solely given to a child during their marriage or cohabitation and further kept separate from a couple’s family property, then the original value of the gift will generally be protected from the division of assets on breakdown of the relationship.
However, any growth in the value of the gift during your child's relationship may not be afforded the same protection. Also, gifts will generally lose their protection if they are co-mingled with the household's family property. For instance, protection may be lost when a child uses gifted funds to pay down the mortgage on their matrimonial home.
Parents may want to discuss prenuptial or cohabitation agreements with their children to protect the gift upon a breakdown of their child's relationship. Further, it is important for your child to seek legal advice regarding protection of any gifts and/or their other assets in a relationship.
Additionally, if you are concerned about preserving the gift for the absolute use of your child and potentially their children, it is recommended you seek legal and tax advice on ways to accomplish this objective both in your lifetime and as part of your estate planning.
What are the effects on your children's motivation to succeed?
“Teach him a dollar earned is of far more value than five found” - Abraham Lincoln, in a letter to his son's teacher.
When thinking of your own household, is it reasonable to argue that the hard work and prudent financial decisions you had to make over your lifetime were chief contributors to your current financial success? Could the result of your efforts to make your childrens' lives easier actually rob them of the opportunity to learn good spending and saving habits in their adult lives?
If you feel it is none of your business how your children spend their gift, the concerns outlined above may not apply. However, if you are worried, you may be better off starting with smaller gifts and make it clear what your intentions are for the funds (retirement savings, education, medical expenses, mortgage prepayments, etc.). If and when your child shows that they have spent or saved the smaller gifts wisely, it may then be time to consider a larger sum.
The above concerns and considerations are also applicable in your estate planning. As such, you may want to discuss with your estate planning lawyer the use of testamentary trusts in your will to protect your children in a number of circumstances, including in a relationship. Again, it is always important to seek legal and tax advice regarding your estate planning, particularly when considering the use of testamentary trusts.
Can you/should you gift equally?
Fair is not always equal. In your family, one child may have a greater financial need than others. As a parent, you may be tempted to provide a greater degree of financial assistance to that child. Some questions to pose to yourselves before gifting are, how will this affect your relationship with your other children and the relationships between siblings? Will anyone shout, “That’s not FAIR”? What is your view on what is fair and what is equal?
Clear communication is recommended with all of your children to outline the rationale behind your decision. You may wish to document your intentions and include that document with your estate planning documents. Your decision to gift will be based on your family values and goals and while it may seem onerous and unreasonable to have to explain your reasons to your children; the absence of an explanation may lead to your children making up their own stories, creating hurt feelings that can last a lifetime.
Ultimately, if providing equal gifts to your children is important to you, you may be able to equalize the amount received by each child over time or even through the distribution of your estate. For example, you may elect to treat the funds gifted to a child currently experiencing financial hardship as an advance against their share of your estate.
What are the tax implications of living gifts?
In Canada, unlike in the US, there is no gift tax levied on either the giftor or the recipient. However, that does not necessarily mean the process of making a gift to an adult child is a tax-free transaction. If you are gifting something other than cash, taxes may apply.
Under the Canadian Income Tax Act, property is deemed to be disposed of for a fair market value price when it is gifted to an adult child, regardless of the amount of consideration received. If the gifted property has appreciated in value since you acquired it, the deemed disposition would normally trigger the taxes you owe on that gain. This can be particularly noteworthy for capital properties like an investment portfolio or a rental or vacation property.
That said, future potential tax savings may be achieved when gifting assets. If your adult children are in a lower tax bracket than you and can invest the gifted assets, their investment returns may be taxed at a lower rate than you, had you made the same investment.
While the deemed disposition is the most common tax effect from giving gifts in Canada, there can be several other less common tax implications that depend on the details of your gift and the recipient. Not discussed here but equally important to note, gifts to minor children or spouses are treated differently than gifts made to adult children under the Income Tax Act. It is typically wise to seek tax advice before gifting property.
Should you gift to your adult children?
Gifting thoughtfully to your adult children can be fulfilling for you and provide your children a much needed leg up in life. Taking the time to work through your decision will help to ensure your ultimate objective is achieved and may help you avoid some of the pitfalls discussed. Finally, most importantly, seek professional advice before making any commitments.
If you'd like to learn more about your capacity for gifting to your adult children or reaching your financial goals, contact our ATB Wealth advisors.
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