The juice isn't worth the squeeze. The math behind informal trusts or ITF accounts

In Trust For Accounts (aka informal trusts) are overhyped when it comes to the tax savings in my opinion.

Yes tax savings matter BUT once you factor in that you HAVE to give the money to your child at the age of 18 - the small tax savings don't seem worth it.

Let's dive in ????

An "in trust for" account functions in the eyes of the CRA the very same as a formal trust.

There are all the same parties (Settlor, Beneficiary, Trustee) and the structure/idea of control and one party (usually parents) holding the money for another party (kids) applies.

3 key differences apply however that "seem" to make it appealing for families looking to shift the tax burden.

- Less legal requirement - no legal trust paperwork is required to set up

- Capital gains taxed in the child's hands

- Under $50K no trust filing required

This "sounds" great in theory but what are the tax savings on 50K?

If we assume a 6% rate of return (close enough to most major expected return guidelines) and a market portfolio of mainly equities...that 6% return breaks down into roughly 2% income and 4% capital gains.

Since income is taxed in the hands of the parents we're only shifting the 4% capital gains to the child.

Assuming a top marginal tax rate of 50% and 0% for the child (who isn't earning money) and factoring capital gains rates we are looking at:

50% * 50% * 4% = 1% tax

1% on 50K

So the taxes saved are $500 per year.

Not bad...and it will grow a bit so it starts to seem worth while. By my estimate 18 years is about $16K - $17K in tax savings.

Until you remember the key issue: Your kid get's the money at 18. No If's, ands, or buts.

50K compounded at 6% for 18 years comes to about $140K (I'm assuming the parent pays the tax and the ITF account just compounds).

Are you prepared to hand your kid $140K at the age of 18 in addition to supplementing with RESP dollars?

Seems like a lot of money to hand over...

At 50K you now have to file a trust return and your kid has to file a return for their cap gains regardless of the amount.

So you've added majority of the annual headache anyhow.

All to avoid a legal trust structure and giving your kid $140K at age 18. Doesn't seem worth it.

A small amount like 10K requires a tax return for the child and you are only saving 1% * $10,000 = $100. Why bother?

TLDR

If it's a small amount - an ITF isn't worth the headache. If it's large enough to save real taxes - set up a formal trust.