The baby boomers, that great swell of Canadians born in the first 20 or so years after the Second World War, are retiring, and judging from Statistics Canada data they are retiring in decent financial shape. In 2016, the median net worth for a family with the major income recipient aged 55 to 64 was $669,500. For a senior family (eldest partner is 65 or more), this figure was $762,900. These numbers are set to rise substantially as this cohort will inherit an estimated $750 billion over the next decade according to a 2016 CIBC Capital Markets report.
Not surprisingly, some seniors and pre-retirees are giving their children at least some of their inheritance now. The money has a positive impact on their children's lives. It can allow them to buy a home, and the parent(s) can witness their children enjoying the money. However, careful evaluation of the pros and cons of such a gift is essential before any assets change hands. A living inheritance will not suit all family circumstances.
"If you are considering a living inheritance, you must first make sure your own financial house is in order before you start giving your wealth away," says Ian Black, a fee-only financial advisor and portfolio manager at Macdonald, Shymko & Co. Ltd. in Vancouver.
Retirees must be certain that they retain sufficient assets to enjoy the retirement lifestyle they desire and avoid running out of money. Pre-retirees must consider how the gift will affect their planned retirement date and lifestyle. Will the gift mean delaying retirement to earn additional funds? If so, will your health allow you to work the extra years? Will there be suitable work available?
"When assessing the feasibility of a living inheritance, we like to stress-test a client's financial plans by asking the question: If your net worth decreased by 20 to 30%, would you still be able to afford the gift?" says Black.
Another crucial consideration is how the planned gift will affect your child. Clearly, your intent is for the gift to have a positive impact, but will it? Is she mature enough to avoid squandering the money? Will the gift destroy her ambition? Does she have sufficient financial literacy to make sensible decisions about the inheritance?
Gifts that address specific needs of a child such as paying off student loans or help with a down payment for a home are generally well received.
There are ways to address at least some parental concerns about the negative impact of a living inheritance:
- Delay the gift until the child reaches a certain age or milestone such as college graduation;
- Arrange for training in financial management before giving the money;
- Give a small sum initially and monitor how the child handles it;
- Place conditions on the gift, such as limiting the use to the down payment on a home;
- If the gift is intended to establish a business, require the child to provide a detailed business plan and match any gifted money.
The impact of a living inheritance on the siblings of the recipient must also be taken into account before any funds are dispersed. For the sake of family harmony, fairness in giving to all children is vital. If one child receives funds toward a home purchase, their siblings should receive an equivalent gift, even if they do not intend to buy homes.
The tax implications of a living inheritance can be considerable for both parent and child, and merit investigation before any decision regarding a gift is made.
There may be tax savings if you give money or property to your children while you are alive. No probate fees are payable. If your child is legally an adult, profits generated by the gift money will be taxed in her hands, possibly at a lower tax rate.
If you need to sell investments to raise money for the gift, capital-gains tax will be payable on any profits. If you plan to give real estate, consulting an accountant is crucial, since the tax treatment can be complex.
Canada has no gift tax, but large gifts of money and property will pique the interest of the Canada Revenue Agency, according to the income-tax consulting firm FBC.
Given the complexities of Canada's tax rules, seeking the advice of a tax professional when considering a living inheritance is likely money well spent.
A living inheritance should be formally documented, particularly if there is more than one child in the family, in order to avoid future disputes among siblings. At a minimum, parents should prepare a letter outlining the terms, including clearly indicating whether the inheritance is a gift or a loan. The gold standard for documentation is a deed of gift prepared by a lawyer.
If the gift goes toward buying a home for your child and her family, seeking legal advice before advancing the funds is essential to ensure that your child will keep the gifted funds if she splits from her spouse. A common way to address this concern is to hold a registered second mortgage on your child's home, but expect no repayment unless the home is sold due to a marital split.
A living inheritance could be of great benefit to your family. If it's made after a careful evaluation of all the implications, it's the best way to realize a positive outcome for both you and your children.
