One of the greatest gifts we can give children is education.
When it comes to post-secondary education, this gift can come at a significant cost.
There are several ways that parents can choose to deal with the cost of a child’s post-secondary education.
Today, many young parents are struggling to make ends meet. Paying the household bills, including the mortgage, leaves little left over for education planning. Contributing to a Registered Retirement Savings Plan (RRSP) provides a deduction from taxable income whereas a Registered Education Savings Plan (RESP) does not provide this immediate tax relief.
Planning for education costs
Some parents have not created an education plan. What happens in these situations is either the parents adopt a “pay as they go” approach or may expect a child will be responsible for their own education costs. This could be funded through the child’s personal savings (if they have any), receiving scholarships (if possible), using student loans, or getting a part time job. With whichever method parents choose to assist their children, it is important to keep a mental note of the potential costs for budgeting your cash flows.
Contingency plan for education
Like all plans, your future costs should also factor in the unexpected. An unanticipated disability, death, divorce or other family emergency may interfere with your children obtaining an education. In many cases, purchasing adequate insurance may offset some of the risk if a supporting spouse were to become disabled, suffer a critical illness or pass away. The cost of term insurance for parents is very low and, in my opinion, worth considering in most cases. We will typically prepare a term quote for our younger clients after doing a needs analysis. The two most common items on a needs analysis typically cover debt (i.e. remaining mortgage balance) and future education costs for minor children.
Take advantage of the Canada Education Savings Grant (CESG)
The government provides a 20 per cent CESG for contributions of up to $2,500 annually. Obtaining an immediate return of 20 per cent, or $500, should not be missed. If you have missed a RESP contribution early on, then the government will even give you the flexibility to claim the CESG for up to two years – if you contribute $5,000 in a single year you will receive a $1,000 CESG from the government. The lifetime total benefit for the CESG is $7,200 that the government will give for your child’s education, provided you have mapped out a plan to contribute $36,000 over 17 years.
Income splitting benefits of RESP
Normally, when you give your minor child money, interest or dividends earned on this money is taxed as if you had received the income (i.e. income is attributed back to the parent and taxed in their hands). Capital gains income does not attribute back to the parents. The attribution rules do not apply to RESP contributions either. Both the tax deferral and income splitting are particularly beneficial if parents have high taxable income. The lifetime maximum to contribute into a RESP is $50,000 per child. Although the extra $14,000 ($50,000 - $36,000) may not attract the CESG noted above, there are both income splitting and deferral benefits to consider.
Planning contributions
We encourage clients who open up a RESP for a child to contribute $2,500 every year. We will go into the benefits of compounding investment returns in next week’s article. Lump sum contributions for higher income parents work best, as you can do a contribution early each year. Alternatively, setting up pre-authorized contributions (PAC) is another easy way for a family to get started with automated forced savings each month. When a RESP is set up, we can also set up the PAC at the same time.
Grandparents opening plans as subscriber
Many grandparents are proud to start the next generation off on the right foot. Funding an RESP is a great way to help both their children and grandchildren. Godparents, friends and other family members may also be the subscriber of a RESP for a child. Nearly half of the RESP accounts we have opened are funded by grandparents. In a couple of weeks, we will discuss different ways that RESP withdrawals can be structured. In some cases, grandparents may want their original capital back (if they require it), and the grandchild can receive all the CESG and income within the plan. When a grandparent opens an RESP for a grandchild, we will recommend that they speak with their lawyer to add a paragraph in their will that names another individual as the subscriber, typically the parent(s), if they were to pass away. A grandparent cannot open a RESP for a grandchild unless the parents sign a consent form. The key point to note with setting the account up this way is that the grandparents are the subscribers and ultimately control the account and future withdrawals.
Grandparents gifting funds to children
It can be a little trickier when two eager sets of grandparents both want to open an RESP. In these situations, I would typically recommend that the RESP be opened in the name of the parents. The grandparents can each gift money to the parents; the parents can then contribute the funds into an RESP. When the gift approach is used, the parents are the subscribers, not the grandparents. The parents would ultimately control the account and future withdrawals.
When we meet with grandparents to discuss the option of gifting money to the parents, we also offer to assist the parents. We can open the account with the parents being the subscribers. Although this is a small account to begin with, we can easily link the account to reduce investment council fees which we refer to as “house-holding”. The nice benefit of this option is that the grandparents can transfer money from their non-registered investment account directly into the grandchild’s RESP. We can then meet with the parents and communicate with them regarding the contributions (ensuring they are within the government thresholds), and investment options.
Individual versus Family
An individual plan is set up for the benefit of one person. A family plan is set up to allow contributions to be made for more than one beneficiary. The one condition is that all the beneficiaries must be related to the contributor(s) by blood, but not nieces or nephews. Contributors decide on how the plan’s assets are invested along with the timing and amount of the education payments. The main benefit of a family plan is that RESP income does not have to be paid out proportionately between beneficiaries. If one child does not pursue post-secondary education, the other beneficiaries may use the income for their education. One common misconception is that you must have more than one child to open up a family plan – that is not the case. If there is any possibility of the parents having additional children then always open up a family plan. There are no disadvantages to having a family plan with one child. When we see parents with more than one individual plan, we will assist them in transferring these into family plans and communicate the benefits of doing so.
Self-directed option versus pooled fund
There are different types of RESP accounts depending on the financial institution you visit. The two main types are self-directed plans and pooled programs. Our preference with any type of investment account is to keep things simple, low cost, and flexible. This can all be achieved with the self-directed RESP option. Pooled programs may require a minimum deposit, regular contributions, and have various up front and ongoing service fees.
We recommend anyone considering a pooled program to also explore the self-directed option and compare both for fees and flexibility. Too often, we see people rushing out and purchasing a pooled RESP program without understanding all the fees and features.
Many of the pooled options available have features that are unnecessarily complicated. Wherever you initially open a RESP, we feel you should have the right to move the RESP if you are not satisfied. With many of the pooled options, it is very punitive to transfer out of the program. With a self-directed option, you have complete flexibility to pick the underlying investments.
Opening a RESP is certainly a significant step in the right direction. Next week, we will provide a few tips on how to structure the contributions and maximize the benefits of a RESP.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250.389.2138. greenardgroup.com
