Ways to give money to grandchildren who have maxed out their RESPs

Q.

My spouse is near the end of her life and she has approximately $60,000 she wants to transfer to her son to be used for her

two grandchildren’s education

. I suggested she could transfer the amount to her son’s

registered retirement savings plan

(RRSP) while living without

triggering any tax implications

. He has the contribution room available. No one agrees with me. What is the best and cheapest way to get these funds to her son for the grandkids? And is the RRSP contribution a good way of doing it? If not, is there something better? We have already topped up both of my grandkids’

registered education savings plans

(RESPs).

—Thanks, John

FP Answers:

I am sorry to hear about your spouse’s health issues, John. Planning at a time like this can be difficult.

From a tax standpoint, Canada does not have gift or inheritance tax, but several provinces have estate administration tax or probate that can range from a few hundred dollars to as much as 1.695 per cent of the value of an estate. From that standpoint, if she left the $60,000 to either your son or grandchildren at death, those funds would likely be subject to probate if they passed through your spouse’s will. Keep in mind that U.S. citizens could face gift or estate tax implications that may or may not apply in this case.

Also, if these funds are left to her son via her will probating the will could take several months, which means a delay in receiving any funds. The major perceived downside of gifting the funds now would be the loss of control of the money as it changes ownership.

If your spouse’s funds are currently held in her RRSP account, there would be tax on her withdrawal. RRSP withdrawals could be taxed at marginal rates in the 20 per cent to 50 per cent range depending on what other income your spouse has in the year of withdrawal. Similarly, at death the RRSP is considered to be withdrawn in full and the amount will be added to that year’s income tax return. Whether the funds are withdrawn during her lifetime or at death, and even if her son is a named beneficiary, the proceeds are taxable to your spouse.

To be clear though, John, if these funds are in your spouse’s RRSP, she cannot transfer them directly to her son’s RRSP on a tax deferred basis. She will have tax on the RRSP withdrawal and he may save tax with his RRSP contribution.

Assuming your spouse gives $60,000 to her son, it would be his choice to make an RRSP contribution or not. If he has contribution room as you stated and his income falls into a high enough tax bracket he will have a tax refund for making this contribution. The deduction for this contribution could also be carried over to a future year and deducted over multiple years if it made sense or he could even provide the money to his spouse to make a spousal RRSP contribution to an RRSP in his name. If there is a desire for these specific funds to flow directly to the grandchildren someday a separate RRSP could even be established listing them as beneficiaries (which is revocable).

The problem with this strategy is that if the goal is for the ultimate beneficiary of the gift to be the grandchildren, having her son put the money in his RRSP may not be the best way to implement the strategy. If your spouse wants him to withdraw from his RRSP for educational expenses for her grandkids, he may be in a higher tax bracket at that time, making the strategy less beneficial.

The cheapest way to implement this strategy likely requires a level of trust that the funds are going to be used for education purposes if your spouse makes a direct gift during her lifetime. Any other plan will involve more complexity in order to provide more assurance that the proceeds end up used for the grandchildren’s education.

An example of a formal strategy could be the use of a

testamentary trust in her will

for her grandkids, with her son as trustee. The trust could be established specifically for the grandchildren’s education or it could be more generally for their education and advancement in life in order to be more flexible. The testamentary trust could invest the money until the grandchildren start attending a postsecondary program, at which time the proceeds could start to be provided to the children. A downside of trusts is that formal trusts have accounting and legal fees to consider. If we are looking at a $60,000 trust, the cost to maintain it could be high.

I have seen parents over the years hold funds in a taxable investment account on behalf of their children — a so-called informal trust. The parents pay the taxes on the income as if it is their own. In a situation where there is RESP room, an obvious strategy would be to top up those accounts. But if there is no RESP room, an informal trust that is simply in her son’s name is another less formal, less certain solution.

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In summary, John, there is no right answer here. But if the RRSP idea is because the funds are in your spouse’s RRSP, she cannot transfer the money on a tax deferred basis. A formal testamentary trust in her will may be the most ironclad way to do this for her grandchildren’s education. A gift to her son to hold the money informally in trust for the grandkids is also an option.

Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at adobson@objectivecfp.com.

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