How to gift money to your children

Carmen is considering an RRIF withdrawal to transfer money to her children. But is there a better way?

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Q: I would like to give some money to my children while I’m still alive. If I take it out of my RRIF, is there any way to reduce the income tax? I would be paying at least 40% in taxes and maybe more if Prime Minister Trudeau has his way. I heard somewhere that maybe I can gift it to them through a trust fund?  

 — Carmen

A: I think that considering an early inheritance for your children can be a fabulous idea. If you have a lot of money, it can help to stagger the shock of a sudden windfall for your children. And if you only have a little to pass along, it may be “a lot” for your kids – especially if they are at a point when they really need it.

In your case, Carmen, a Registered Retirement Income Fund (RRIF) withdrawal can be an expensive way to pass the money along. Withdrawals from a registered account like a RRIF are fully taxable and added to your other income for the year. If you have $25,000 of income and live in BC, you might pay 22% tax on an additional $10,000 withdrawal. But if you have $100,000 of income and live in Quebec, you might pay 62% tax on an additional $10,000 withdrawal (including the Old Age Security clawback).

The thing with a RRIF is that unless you leave it to your spouse, it’s going to be fully taxable on your death anyway as if you withdrew the money at that time. You can’t avoid the tax forever. Accelerating the tax may not be the best option, but as long as you’re not compromising your own financial security by gifting the money away, it’s certainly an option for you, Carmen.

As far as reducing the tax on a RRIF withdrawal, the options are limited and in particular for a retiree. And quite frankly, I don’t think things like flow-through shares or donation tax credits are likely to help you achieve your stated goals.

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I wanted to touch on Trudeau’s proposed personal income tax changes, Carmen. Part of his election platform was to lower the middle income tax bracket for those earning $44,700 – $89,401 by 1.5%. So unless you are earning more than $200,000 per year – including your potential RRIF withdrawal – you may actually be better off if the Liberals go through with their election promise on personal income tax changes. If your income exceeds $200,000 including the RRIF withdrawal, you would be paying 4% more tax on any excess.

However counterintuitive this might seem, Carmen, you might be a good candidate for taking on some debt to achieve your goal. If the only source of funds you have is your RRIF – which may be taxable at over 50% (62% in my $100,000 income in a Quebec example) – borrowing might be a better option. I’d definitely start with non-registered or TFSA investments if you have them.

Otherwise, if you can borrow at 2-2.5% on a mortgage, even if your RRIF is earning a modest rate of return, your RRIF income should keep pace (or close to it) with the interest you’re paying on the debt. In other words, earning 2-2.5% on your RRIF is at least keeping pace with the 2-2.5% you’re paying on the mortgage. But if you’d otherwise only have 38 cents on the dollar to give to your kids after a RRIF withdrawal (assuming 62% tax leaves you with only 38% of your withdrawal after tax), why not consider keeping your RRIF intact, borrowing some money and giving them 100 cents on the dollar instead?

Borrowing in retirement is something that should be done with a high degree of caution. Don’t ever put yourself in a position where you are overextended. Make sure you understand the ongoing cash flow implications of servicing the debt, including when interest rates rise. You may need to take additional withdrawals from your RRIF to make the debt payments, but at least this only results in a little bit of tax over the subsequent years instead of a lot of tax right now.

You ask about a trust fund and yes, trusts can be useful in reducing income tax. Generally though in the context of reducing tax on investments this would only apply if you had a large amount of taxable, non-registered investments. The tax savings would come from the investment income earned each year which may be taxable at a lower rate in the hands of your children or grandchildren. In other words, it doesn’t apply in your situation, with only a RRIF to work with.

There are always different ways to accomplish your financial goals. A little planning can help you weigh the pros and cons. Ultimately, it’s your money and you can do what you want with it, Carmen, but always try to use your money in the best ways possible.

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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.

One comment on “How to gift money to your children

  1. As mentioned, the big question is where your income falls in relation to the marginal tax brackets. You may also want to consider your age. If you expect to live for quite a few more years, you can take extra money out over a number of years. If you are close to the big one, that money will come out in a lump sum, and be taxed at a higher rate. There are many things to consider. Without knowing your exact circumstances it is hard to give you complete advice.

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