Of all the strategies in the art and science of wealth management – like balancing a portfolio, tax mitigation, risk and asset protection, estate strategy, the Rule of 72 and the 80/20 rule – there is not much practical theory or sage advice about lending money to the kids. Yet, it is a relevant and important aspect of smart wealth management.
As savvy financial planners and wealth management professionals acknowledge (and caution), the cold and hard rules and protocols of wealth management get blurred by emotion when it comes to The Bank of Mom & Dad. Emotion and family are notorious deal changers.
The serious factors and implications kick in when the money is more than helping with maxed out credit cards, phone bills, groceries or missed rent or car payments. A recent Abacus poll found that 41 per cent of parents of children aged 18 to 38 chipped in to help finance their home purchase. Whether the wealth planning parents are gifting or loaning money to their adult children, there are tricky income tax, retirement, family law and estate planning speedbumps to consider.
“Most would agree that a parent’s job is never done,” says Bernadette Churchill, private wealth advisor and portfolio manager with CWB Wealth, “and as we strive to set our kids up for success, a well-planned financial gift from mom and dad can certainly make a difference.
“However, before one moves forward with gifting or lending to adult children, the parents should have a firm understanding of their current finances and future needs. Especially nearing or in retirement, it is important to ensure that the gift fits within personal financial capabilities and does not create a debt obligation for the giver.”
A vital factor to consider about lending or gifting money to adult children are immediate or foreseeable Canadian tax implications and who is impacted: the lender or the recipient?
There are generally no tax implications for giving cash to your children. Gifts to adult children are neither taxable to them nor subject to income attribution in Canada, though there may be gift or estate tax implications for U.S. citizens in Canada.
If an asset is transferred to a child and appreciates in value, it may trigger a capital gain for the lender. Assets like stocks or real estate have a deemed disposition at their fair market value, even if it was gifted. If the asset subsequently produces income for the adult child, that income is taxable to them.
Anne Wildfong, also a private wealth advisor and portfolio manager with CWB Wealth, emphasizes that, “It is important to consider being purposeful with family gifting to ensure that you are not creating a dependence with your adult child. If you are intentional with your financial gifts, you can empower them with greater financial flexibility. There is a difference between providing money for higher education so that they can further their career, versus putting it toward day-to-day expenses.
“Be clear and let your child know that the money is a gift, an advance on their inheritance or a loan. This will alleviate any confusion and set clear boundaries. If it is a loan, documenting the terms will ensure that both parties understand the expectations,” she says.
Experienced financial planners urge that, although lending money to adult children is ultimately a selfless, generous and invariably emotional decision, the focus must remain on the individual’s wealth management needs and priorities. It is all part of the do’s and don’ts about sensible and wise gifting money to adult children.
“Parents must review their own financial plan thoroughly – in particular, their detailed retirement plan—to ensure they have the financial capacity and flexibility to give money to their adult children in the first place,” cautions Markus Muhs, a portfolio manager and financial planner with Canaccord Genuity Wealth Management (CGWM) in Edmonton.
“Often emotions and family bonds drive such decisions without consideration for whether or not what’s left will get the parents through retirement. The adult children may be able to defer the purchase of their first home or fund their wishes through some other form of financing, while retired people have far fewer options.”
Muhs points out some common risks and pitfalls when it comes to parents gifting or lending money to adult children.
“For example, when gifting money for a home downpayment, it is important to have a proper gift letter signed, specifying that the money is an irrevocable gift. Banks and mortgage brokers will generally guide people through the requirements, because it is important for the lender to be assured that the downpayment itself is not comprised of borrowed money. A gift letter is a good idea in any case, whatever the purpose of the gifted money is, so that there is a paper trail of money transferring from the parent to the adult child.”
Wealth management professionals are adamant about dotted i’s, crossed t’s, details, paperwork and agreements.
“Before giving large monetary gifts to your adult child, be sure to understand the implications,” Churchill points out. “Will it trigger tax consequences for the parent and possibly the recipient? It might be prudent to sit down with a financial advisor or accountant to review and understand all potential outcomes, and possible tax consequences, that would result from the gift.”
Muhs urges a focus on the tax implications about lending or gifting to adult children.
“Often most of a parent’s assets are inside of registered plans (RRSP/RRIF). Technically the balance of such an account represents a pre-tax value, not actual wealth at hand,” he says. “When withdrawn, this money becomes taxable income. Parents should never make a big lump sum withdrawal from an RRSP/RRIF to help their children buy a home. It is a very inefficient use of assets which had their taxes deferred for so many years.”
Wildfong adds, “Consider the complexities within relationships that will be affected by the gift and be sure about the details of how it will be distributed or retained. Intentions should be clear and possibly mentioned in a cohabitation agreement or pre/post nuptial agreement.”
“Parents may think that their gift will always remain with their child,” she adds, “But when it is comingled with marital or cohabitation assets, ownership can become unclear. Family dynamics may mean these conversations with an adult child will be challenging, so consider involving a trusted financial advisor or lawyer to create clarity and legality around the gift.”
Awkward or not in family situations, verbal deals and promises may be nice, but a paper trail is essential.
“Money can be a sensitive topic,” Churchill notes, “and it can easily impact family relationships. Under certain circumstances, having a formal document outlining the terms of certain monetary gifts or loan obligations can minimize any confusion.”
She adds that putting it all down on paper is important and involving a wealth manager for large amounts or commitments can help ensure that the arrangements are within the person’s financial plan and that the larger commitments will not cause undue hardship.
Spelling it all out on paper also helps to determine how the gift will impact the person’s tax situation and other aspects of the retirement or estate.
