Launching Young Adults Toward Financial Freedom

Many young adults face a savings dilemma. They may understand that the sooner they begin investing, the greater the effect of compound growth in building wealth for the future. But they can’t put money away because they have more pressing financial needs now.

Do you have a child or grandchild in such a situation? They may be a post-secondary student or an individual who’s starting out and doing their best just to meet today’s cost of living.

You may be able to help them save for the future in one of the following ways.

Helping to save for a home

A young adult with the goal of owning a home may want to open a First Home Savings Account (FHSA). The time horizon is relatively short – an FHSA can only remain open for 15 years. This means that to benefit the most from compound growth, your child or grandchild should contribute as much as possible, as early as possible.

Ideally, they would contribute the maximum annual amount of $8,000 for five consecutive years to reach the $40,000 limit. That may simply be unattainable for many young adults. But with your help, they may reach or come closer to making the optimal contributions.

Topping up RRSP contributions

A young adult in the early years of their working life may be paying off a car loan, covering their rent or even a mortgage and doing their best to cover the cost of living. They’re generating Registered Retirement Savings Plan (RRSP) contribution room but might only be able to contribute a small amount. You can gift them funds so they can make their maximum RRSP contribution.

If your child or grandchild has a low income, let them know about deferring the RRSP tax deduction. They can defer the deduction to a future year when they have a higher marginal tax rate and will save more tax.

When goals may be flexible

Some parents or grandparents may want to take advantage of a child’s or grandchild’s Tax-Free Savings Account (TFSA) for family income-splitting. Although the gifted funds are after-tax dollars, all growth and income earned in the account is entirely tax-free.

With a TFSA’s flexibility, a young adult can use the account to meet virtually any want or need, whether they’re saving for a vacation, a car or retirement.

If you have a child or grandchild interested in saving now for retirement – perhaps, thanks to your encouragement – a TFSA can be ideal. Gifting funds when they’re at a younger age gives them great potential to capitalize on compound growth over the long term. The young adult could even open two TFSAs, one for short-term and medium-term goals, and the other for retirement savings. This way, they can more efficiently allocate assets in their retirement savings TFSA to suit a decades-long time horizon. Also, they’re more likely to view funds in this account as untouchable, which may not be the case if all contributions are co-mingled in one TFSA.

The gift of compound growth

How a $35,000 gift exceeds $285,000 by retirement

A parent gives their child $7,000 to invest in a Tax-Free Savings Account (TFSA) upon the child turning 21. The parent continues making this annual gift for four more years, for a total of $35,000. This chart assumes an annual rate of return of 5.00%.

This chart is only intended to illustrate the general principle of compound growth and is not indicative of any investment.