As a pre-teen, if I didn't get my chores done I got no allowance. Protesting that Mom was violating child labour laws, she handed me the phone and advised me to call somebody who cared. "You get those chores done PDQ! (pretty darn quick)."
I drooled over the $20 bills my best pal invariably got for his birthday. Unearned, it slipped through his fingers like water, while I often cleaved to my hard-earned 25 cents with Charlton Heston-like passion.
One sunny Saturday afternoon I resisted cutting the grass, arguing that the effort was underpaid and difficult. The truth was that I was deeply heart-broken over a cute girl in my class.
Mom cajoled me into action, refusing to leave for her Saturday shopping until the lawnmower was engaged in my hands - but showed flexibility by pre-paying me my two bits. I don't know what got in to me, but instead of cutting the lawn, I etched a large heart shape in to the grass, with the initials of the pretty little blonde-haired girl in my class inside it. Pleased with the result, I tucked the lawnmower away and walked to the corner store to drown my sorrows in a bottle of pop (15 cents) and a bag of chips (10 cents). Guilt-ridden, I went to the ballpark and climbed a large tree, and sat there for two hours, warm pop and chips in hand, unable to enjoy the spoils of unearned compensation.
Many school-age children start working part-time after school or on weekends in their late teens to earn some pocket money. It gives them some freedom, a sense of purpose, a chance to learn about saving and, most importantly, an appreciation for the value of money. However, there is yet another oft-ignored advantage.
People who earn taxable income of less than the basic personal exemption are not required by law to file a tax return but it is worth taking the time to file a tax return anyhow. Here's why:
Building RRSP contribution room can only be achieved by having earned income that has been documented with the Canada Revenue Agency (CRA), by filing a personal tax return. By so doing, your minor child will start to accumulate RRSP deduction room at the rate of 18% of earned income.
Example
Assume two schoolmates, Bob and Joe, each get summer jobs at age 13. They each earn $4,000 every summer, and at age 22 they both get career jobs after graduating from university.
Bob's parents file a tax return each year on Bob's behalf while Joe's parents do not. This extra effort generates $6,480 (($4,000 x 18%) x 9 years = $6,480) of RRSP contribution room for Bob by the time he graduates from university. The tax rules allow for an indefinite carry forward of unused RRSP contribution room, so this RRSP contribution room accumulates for Bob from age 13.
By age 22, Bob will be able to save approximately $2,000 ($6,480 x say 31% tax rate) in taxes if he contributes the full amount of his carry forward room to his RRSP in his first year of employment. By age 60, that extra $6,480 will grow to nearly $60,000 (at a growth rate of just 6% per year). Not bad for sparing a half an hour of time each year to prepare a tax return! Not only is Bob saving taxes that Joe has to pay, but he has started securing his own future because of his parents' smart thinking.
Other benefits
Educational: If you involve your children in preparing their tax returns, they will learn a new skill that can help instill good financial management habits.
Income splitting: If you own your own business and hire your children, you'll get the extra advantage of income splitting. There is no attribution on business income received by a child. Keep in mind that the salary you pay them must be "reasonable" for the services they provide. As a rule of thumb, to define "reasonable" is to ask yourself what you would pay a stranger to do the same work.
Tax-deferred compounding: To take advantage of additional years of tax-deferred compounding, you could make the contributions to your child's RRSP annually but only claim the deduction when your child's income escalates into the higher tax brackets. The tax rules allow undeducted RRSP contributions to be carried forward indefinitely. However, please note that although the CRA does not have any restrictions in this regard, not all institutions can accommodate opening RRSPs for minors.
Summary
If your minor children have earned income, help them file their own tax return, even if they have no tax payable. This is the only way to create RRSP contribution room early, and is also a great way to help them get into the habit of saving and learning about the benefits of compound growth without indulging them with a handout.
Mark Ryan is an advisor in Prince George with RBC Wealth Management, and can be reached at [email protected].
