Helping children onto the property ladder
Parents need to understand the financial impact of this major decision.
The high interest rate environment and above-average real estate prices in many parts of Canada can make home ownership a challenging goal for many young adults. Saving for a down payment is an enormous task requiring dedicated strategies to stockpile the necessary funds. But when homes in many major metropolitan centres sell for $1 million or higher, coming up with a 20 per cent down payment might feel next to impossible. (It’s important to note that in less competitive markets, such as the prairie provinces and eastern Canada, more cost-effective real estate options are available. Home purchases of $500,000 or less require only a five per cent down payment.[1])
So how does a young person come up with hundreds of thousands of dollars for a down payment if their heart is set on living in a pricier part of the country? Careful budgeting and socking away every spare dollar is essential – and a sizable salary also helps. A recent report indicates that to afford a home in Vancouver or Toronto, you should have an annual individual or combined income above $215,000.
Parental financial support is another option that is becoming increasingly common. A survey by the Ontario Real Estate Association finds that four in 10 parents are helping children aged 18 to 38 with their real estate purchase. Whether they offer gifts or loans, parents are either dipping into their general savings or withdrawing from their retirement savings and investments.[2]
Curtis Davis, a taxation specialist with Manulife Canada, says parents should understand a few things in advance of helping adult children with a home purchase.
Financial gift
Parents who may be thinking of giving children cash towards the price of a home will be happy to learn that there are no gift taxes involved whatsoever, regardless of the dollar amount. Whether it’s $300, $30,000 or $300,000, money can be given to a child completely tax-free.
“In Canada, money given by parents to a child as a gift isn’t subject to tax, whereas in other countries like the United States it is,” says Curtis. “And, because this may be cash just sitting in a savings account, there’s no capital gains or losses to worry about, like with stocks, or taxes owing, such as with a Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF).”
Although the urge to help a child may be strong, you should carefully consider whether an outright gift is something you can truly afford. And that’s where your advisor can help by looking at the strength and position of your overall financial plan. If you’ve paid off all your debt and saved enough for retirement, you might be in a position to forge ahead with making a substantial gift toward your child’s home-buying dreams.
Loan arrangement
With a full understanding of the state of your finances, you may prefer to offer a loan to help with the cost of a down payment. This is slightly more complicated than simply offering a cash gift, and you’ll want to arrange a formal agreement.
“If you’re considering a loan, treat it like a proper business transaction,” says Curtis. “Think through your expectations, get some legal advice, and put things down in writing.”
A few things to consider:
- How do you want to be repaid, and how will the payments be enforced?
- Will you charge interest on the loan? How will that earned interest affect your own tax situation?
- What will happen if your child decides to sell the home?
- What will be the impact on your estate plan if you die before the loan is repaid and other siblings are expecting an inheritance?
It’s important to stress-test your child’s ability to repay the loan. Do they earn enough to handle mortgage payments, property tax, insurance and maintenance costs and still have enough to pay you back? Home ownership is both rewarding and stressful – and it’s important to consider the emotional impact on your relationship with a child if a loan arrangement were to become problematic.
Investments and retirement savings
Funding your own retirement needs to take priority over assisting a child with a home purchase. But if you’re tempted to tap into savings, this is what you can expect.
TFSA
Withdrawing money from a tax-free savings account (TFSA) to give to a child is the same as giving a cash gift, and it does offer advantages over other sources.
“You could use funds from a TFSA with no tax implications, and while money is in there, it can be invested for growth,” says Curtis. “And that withdrawal is calculated into your TFSA contribution limit for the following year.” Learn more about TFSAs here.
Non-registered investments
Over the years, you’ve built up a nice investment portfolio of some stocks, bonds, mutual funds and ETFs. If you’re thinking of cashing in some of it to help your son or daughter buy a home, be aware there will be a tax impact. If you’re selling these investments for more than the initial purchase price, that will be reflected as a capital gain. If you cash out for less than your initial purchase price, that’s a capital loss.
“Look at your portfolio and pick a combination where the gains and losses offset each other,” says Curtis. “This might be a time to trigger gains on purpose, knowing you have losses from previous years to offset them.”
Learn more about taxation of investments here.
Registered investments
Think carefully before withdrawing money from an RRSP or RRIF to help your kids. Not only will this affect your own retirement future, but withdrawals are fully taxable at your marginal tax rate.
Consider the impact of a $100,000 RRSP withdrawal:
- 30 per cent or $30,000 of the withdrawal will be withheld by the financial institution to pay the Canada Revenue Agency
- You’re only then giving your child $70,000
- If your marginal tax rate is higher than 30 per cent, you may owe more tax than the amount withheld, which will be calculated on your next tax return
“It's a really expensive way to go,” says Curtis. “It's fully taxable income, your child doesn't even get the full amount, and then depending on your tax rate, the withholding tax may not even be enough to cover the full cost.”
There’s a lot to consider when it comes to helping the next generation get into real estate. Before you make any major decisions, book some time with your advisor to review all your options. And bring your child along to the meeting – if they don’t have a financial plan of their own in place, now is a great time to start.
For more information on home ownership, check out these resources:
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