Guide to Trust Funds for Grandchildren in Canada

Trust Funds for Grandchildren

You want your grandchildren to have a future. This statement seems obvious, but while many people will say it, its meaning is not always the same from one person to another.  

For some people, a future for their grandchildren means having a job. For others, it means having property. But as any economist can tell you, the most secure future is an adaptable future. So, if you want your grandchildren to have whatever future they can dream of, the best way to do that is with a trust fund. 

It is not always easy to set up trust funds for grandchildren in Canada, but it can be one of the best ways to leave them a future they can count on. 

What is a trust fund? 

A trust fund is one of the best ways for grandparents to give money to grandchildren in Canada. 

The typical trust fund is straightforward in terms of its legality and liabilities. A trust is a three-way agreement between a settlor (the provider of the money involved in the fund), a trustee (the person who manages that money), and a beneficiary (the person that receives the money). In most cases, the settlor is a corporation that a grandparent owns, while the trustee is the grandparent. The beneficiary is always the grandchild in this scenario. 

The interesting thing about trust funds is that they do not need a “founding document” in the same way a corporation does. That means that it is not a legal entity with any liability. It does, however, have to pay taxes as if it were a person. That is where trusts start to get a little funny, so if you want to have an extraordinarily profitable or well-protected trust, get a lawyer. 

The basics of a trust are that once the settlor gives the trustee an amount of money, that trustee then uses investments, mutual funds, and other methods of moving money to turn that amount of money into a more considerable amount. In short, a trust fund is a lot like a hedge fund, but instead of using the money of investors, it uses the capital of a settlor, and instead of paying a board of directors, it pays the beneficiary. Trust funds are usually set up by people over 50 and are most valuable when you turn 65. Seasons Retirement has tips for taking care of yourself well into retirement.  

The two types of trust funds  

There are two types of trust funds for grandchildren in Canada: living trusts and testamentary trusts. A living trust is set up while the trustee is still alive. In the case of a living trust, there are two ways to increase its value: Either getting more money from the settlor or investing the trust fund’s money in a manner that yields returns.  

There are many sub-types of living trusts that revolve around how the trustee gets money from the settlor and what money the trustee gives back to the settlor. This needs to happen for the trust fund to remain minimally taxed. 

Testamentary trusts are trusts included in a will. These are used to establish how much money is left to a child or grandchild after the trustee’s death. These used to be taxed far less, but changes in Canadian tax law have rendered them of equal value to a beneficiary as a living trust. This is all to say that neither a living trust nor a testamentary trust is better or worse. 

Trust funds for grandchildren in Canada are taxed like they are people, but that means they can also receive tax breaks like they are people. Depending on how the trust’s money is handled, they can end up being untaxed or even making a profit off of the tax code. For instance, you can establish a living trust known as an “Alter Ego Trust,” allowing the settlor to receive income from the trust. Contrast this to a basic trust, through which the payment of the trust remains in the trust. Income within a trust can be taxed, but if that income goes to the settlor, it is not since it is the settlor’s money, to begin with. 

How does this differ from an RESP in Canada? Read on to learn more about the differences.  

The RESP and how to use it 

In Canada, there is a program you can set up for your child or grandchild called a Registered Education Savings Plan (or an RESP). This type of untaxed savings account is a great way to provide money for your grandchild once they become an adult. There is a limit on the RESP of $50,000, and the child can only access it once they enroll in higher education. However, once they enroll in higher education, the entire sum of money opens up for them.  

The critical thing about RESPs is that they can be used similarly to trusts. For instance, say you invest a portion of an RESP into a stock or bond. That stock or bond grows in value, and you receive a return. If that return causes the RESP to exceed $50,000 in value, the excess money must go to a savings account. And when it does, it goes there untaxed.  

Not only that, but an RESP for grandchildren can receive tax breaks that result in them receiving a tax refund. Once the RESP turns a profit, that untaxed money can be used in any way the savings account holder wants. If they use it on a charitable cause, that charity turns into a tax credit, usually more significant than the sum contributed.  

Can grandparents contribute to an RESP? 

Yes, any relative of the RESP recipient can contribute to it directly and tax-free. This is why these sorts of funds have become the go-to for many grandparents. They are easy to set up, hard to tax, and quickly turn into much more considerable sums of money than their $50,000 limit indicates. Just be sure to speak with a lawyer, an accountant, or both about setting one up, as they have to be set up at either a bank or an institute of higher education. 

The RESP rules for grandparents are the same for the parents, as anyone in a child’s family can contribute to an RESP. 

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