Education savings revisited
With new rules and new options, your education savings strategy may need a makeover. Discover how to make the most out of revamped RESPs, set aside the funds for graduate or professional studies and take advantage of the new Tax-Free Savings Accounts.
New rules for Registered Education Savings Plans were introduced in the last two Federal budgets, making RESPs more flexible and more attractive when saving for a child’s post-secondary education. Even if you can afford to pay for your child’s post-secondary education out of current cash flow, RESPs are worth a look because of the substantial government grants they offer. Furthermore, you may feel comfortable handling your child’s undergraduate degree but how about three years at law school, a medical specialist degree or an MBA, where tuition in Canada can be as much $65,000 per year? RESPs are a great way to tax-efficiently plan for extraordinary post-secondary costs such as these.
Under the old rules, you were limited to annual contributions of $4,000 per eligible child per year, to a lifetime maximum of $42,000. Now, there is no limit on annual contributions and the maximum lifetime contribution per child is increased to $50,000. In addition, the Canada Education Savings Grant (CESG) annual maximum was increased to $500 per eligible child per year, although the lifetime maximum remains $7,200. Changes introduced in the 2008 Federal budget allow RESPs to remain in effect for much longer – 35 years from when they were set up and contributions can continue for up to 31 years. In addition, the government has broadened the list of qualifying post-secondary education programs to include apprenticeships and trade schools, and students no longer have to be enrolled full time to receive funds from their RESP, part-time studies also qualify.
Aim to maximize government grants
Jane Cheong, Vice President and T.E. Wealth consultant in Montreal, says that most people should use the RESP to take full advantage of the free money available from government. The Federal government will contribute 20% of contributions up to $500 annually per eligible child in Canada Education Savings Grants to a lifetime maximum of $7,200. Residents of Quebec can earn an additional 10% in provincial government grants, adding $250 per year to a lifetime maximum of $3,600 per eligible child. In addition, the Alberta government will pay $500 into the RESP of children born in the province on or after January 1, 2005 and an additional $100 when the child reaches age 8, 11, and 14, as long as they are enrolled in school in Alberta and a minimum level of RESP contributions have been maintained. “There is a substantial amount of government grant money available and all you have to do is contribute $2,500 a year to get it. Assuming an 8% annual compound return, maximizing the CESG in an RESP opened for a newborn will add nearly $20,000 to the RESP’s value by the time the child is age 18,” explains Jane.
Maximize tax-deferred growth by starting early
Children are eligible to earn CESG up to the year in which they attain age 18 but earning it sooner is always better in order to capitalize on the RESPs tax-deferred growth. Unearned contribution room is carried forward so it is possible to catch up but the maximum CESG payable in any year is $1,000 so if you delay setting up an RESP it could be several years before you’ve recovered the CESG to which you are entitled. Parents who wait until their child is 16 or older to set up an RESP risk losing the CESG advantage as there are restrictions placed on the eligibility at later ages. “Ideally, parents or grandparents should plan to set up an RESP as early as possible, preferably when the child is born. By contributing $2,500 per year and earning the maximum government grant, they will have $88,268 at age 18, assuming an 8% annual return. For grandparents, this is a wonderful gift for their grandchildren and it allows their own children to free up income for family expenses,” says Jane.
Consider a lump sum gift
Another option is to pre-fund the RESP with an upfront one time maximum contribution of $50,000. Although you will forego all of the CESG except an initial $500, depending on the rate of return, the power of tax-deferred growth can more than make up for it. Earning an average annual return of 8%, a $50,000 RESP contribution will grow to $186,851 by age 18. That compares to $138,212 assuming the same investment return, an annual contribution of $3,333 and earning the maximum CESG. The higher the investment return, the greater the gap between the lump-sum contribution and the annual contribution option.
Incorporate new Tax-Free Savings Accounts into the mix.
Tax-Free Savings Accounts, that will be available in 2009, provide additional planning opportunities. TFSAs are available for any Canadian resident age 18 and older and all investment earnings in the account are received tax-free. Contributions start at $5,000 per year and will be indexed to inflation, increasing in $500 increments. If additional education savings are required, parents can supplement their RESP investments by contributing to a TFSA, which will come in handy if the child pursues graduate school or professional programs. If the funds are not required for education costs, parents can use the money for any purpose without penalty. Alternatively, they can gift the money to the child with no tax consequences.
Jane suggests the following strategy to maximize tax efficiencies if it looks like you’ll have more than enough in RESP assets to pay for a child’s education. The student should take out Education Assistance Payments (EAPs), which are made up of government grants and tax-deferred growth of the RESP. EAPs are taxed in the student’s hands and because they are likely to have little or no income, the EAPs will be received tax-free. The student then contributes the EAPs to a TFSA and the money will continue to grow tax-free. Meanwhile, you can use the capital in the RESP to pay for education and it is also received tax-free as this money was taxed previously.
If you think your education savings strategy could use a makeover, be sure to talk to your T.E. Wealth consultant.
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