For many families, the transfer of wealth has traditionally taken place through an estate. Increasingly, however, parents are choosing to provide an early or “living” inheritance, giving the next generation financial support when it may have the greatest impact. While this approach can be meaningful, it also calls for thoughtful planning to balance family priorities with long-term financial security.
More families are considering some form of early wealth transfer. According to the Ontario Securities Commission’s Profiles of Retirement report, 52% of retirees have provided a significant financial gift to an adult child.
It’s a trend Lydia Potocnik, Vice-President and Regional Director, Estate and Trust Services (GTA Region) at BMO Private Wealth says she’s seeing firsthand as families look for ways to help younger generations cope with rising costs, particularly housing.
While helping children today can be rewarding, parents need to consider how those gifts could affect their own financial security, particularly in retirement, family relationships and tax obligations.
“Parents may have good intentions by offering financial help to their kids,” she says. “But they don’t always think about the impact that it can have on their own financial security and future needs.”
Here are some of the things to keep in mind before offering an early inheritance.
Can you give an early inheritance without compromising your future?
Families choose to provide early inheritances for many reasons. The OSC study found that some do it to help pay for a vehicle or wedding, while nearly one in 10 contribute toward the purchase of a home. Most gifts are relatively modest, with 39% valued under $10,000 and 30% between $10,000 and $50,000. About 4% of gifts exceed $250,000.
Still, as rewarding as it may be to see the potentially life-changing impact an early inheritance can have, Potocnik says it’s important to think about some of your needs 20 or 30 years down the road, especially as the average Canadian lifespan continues to stretch.
Even if you think you can afford to make a significant gift based on the retirement expenses you’re accustomed to today, this might not always be the case. Future health care challenges, including the potential need for long-term care or expensive renovations to allow you to age in your home, are among the biggest risks to plan for.
“If people overlook their own needs, they may give away money they cannot recover,” she says. “It’s almost like making a donation to a charity.” Unless documented as a loan, money given to an adult child can be difficult to recover, she adds.
Should you give an early inheritance as a gift or a loan?
Deciding how much you can afford to give as an early inheritance is only part of the equation. Another is figuring out whether to treat that support as a gift or a loan. As Potocnik explains, a gift works when parents can afford to part with the money permanently, whereas a loan may be more appropriate if the priority is to ensure the wealth stays within the family.
Unlike an outright gift, a properly documented loan may give a family greater control and a legal right to repayment. If the funds are used to purchase a home, the loan may also be secured by a mortgage registered against the property. If the child’s relationship later breaks down, a bona fide and enforceable loan may be recognized as a debt, although the outcome will depend on the loan documents, the parties involved, provincial family-property law and the specific circumstances.
Potocnik suggests that families obtain legal and real estate advice before advancing funds. Those discussions should also address the importance of documenting the loan, including clear repayment terms on the loan and whether any interest will be charged. While charging interest isn’t always necessary, there may be reasons to do so.
If you are lending money rather than giving a gift, be mindful of how it is used. While there generally are no tax issues if the money is used for a down payment on a first home, if the loan is used to generate income, in some cases the resulting investment income could be attributed back to you and taxed in your hands under CRA rules.
Avoiding family conflict
Giving early allows parents to see the impact of their gift and may help reduce the confusion and resentment that can accompany inheritance decisions made through a Will. However, it does not eliminate the potential for family conflict.
Family tension can arise when one child receives a gift or loan for a major purchase, such as a home, particularly if the support is not disclosed to the other adult children. “Challenges to an estate often arise when gifts or loans are unequal and not properly doucmented,” says Potocnik.
She recalls working with one family recently where an adult son who wasn’t as financially secure as his siblings received $150,000 just before his father passed away. Unfortunately, it was never documented beyond the fact that another sibling was in the room when the father offered the gift.
After the father died, the other siblings argued during the estate administration that the $150,000 was an advance on their brother’s inheritance and should be deducted from his share of the estate, rather than treated as a separate gift made during the father’s lifetime. The lawyer who drafted the Will was able to produce notes confirming the father’s intention to make a gift during his lifetime which was not to be treated as a loan. This dispute among the siblings resulted in additional legal costs to the estate as well as a delay in the administration.
Unequal gifts aren’t the only potential source of conflict. Giving an early inheritance to help a child make a purchase or get through a difficult financial period is fine, but providing ongoing support, such as covering rent or other recurring expenses, can present a new set of challenges.
Ongoing support can create financial dependency. If the child is not adequately provided for in the estate, they may make a dependant’s support claim, Potocnik warns. “Be mindful of how long any form of regular and consistent support continues and encourage the child or grandchild to become financially independent,” she says.
Clarity starts with documentation
Working with a lawyer to document an early inheritance is just as important as having a Will. If you offer a loved one a loan, you’ll want to name the parties, the date and the amount, while ensuring the repayment terms are clearly documented, along with records showing whether payments have been made, says Potocnik.
The Will should also specify what happens if the loan remains outstanding when the lender dies, including whether the balance could be forgiven or deducted from that child’s share of the estate. Without clear documentation, disagreements can arise over how those funds should be treated during the estate settlement process. Seeking the advice of an estate planning lawyer can ensure that a Will is properly drafted to reflect what happens upon death if a loan was made to a beneficiary during the testator’s lifetime.
Potocnik encourages parents to find an opportunity to disclose any gifts or loans they’ve made to family, although she recognizes those conversations can be challenging. If it’s not something you want to share with the family while alive, she suggests having a separate document with your Will that explains why you decided to provide the gift or loan. This document can then be shared by the executor with the beneficiaries during the estate settlement process as evidence of the deceased’s intentions.
“Documentation is critical, particularly when funds are advanced to someone who owns a business or is married,” says Potocnik. “In Ontario, a gift used to acquire or improve a matrimonial home generally loses its excluded-property protection.” A bona fide loan may remain repayable, she adds, but it should be clearly documented and, where appropriate, secured by registering a mortgage against the property before the funds are advanced.
Consider the tax consequences
How you fund an early inheritance can be just as important as the decision to make one. “The different ways in which you gift, and the type of asset you gift, can have tax implications as well,” says Potocnik.
While there is no gift tax in Canada, if you have to sell assets to unlock the cash, whether from non-registered accounts or the sale of a cottage or rental property, you may first have to incur capital gains tax. Gifts of property, such as the gift of a cottage to a child, may also trigger capital gains taxes, as transfers between related individuals are generally deemed to be at Fair Market Value for income tax purposes. Since the capital gains tax bill would come after you’ve made the gift, the impact on your wealth could be larger than anticipated. And, when dealing with real estate, Land Transfer Tax should also be considered.
As with most financial situations, before considering an early inheritance, start with a plan.
“We begin with a financial and wealth plan that projects how a client’s wealth may change based on their life expectancy,” she says. “This helps determine how much they may be able to gift or lend to their children during their lifetime while preserving sufficient funds for their own long-term and unexpected needs, including health care or long-term care.”