Education savings beyond the RESP

When an RESP may not be enough

A post-secondary education is pricey and getting more expensive all the time. Even with a $50,000 contribution limit per beneficiary, the Canada Education Savings Grant (CESG) and tax-sheltered compounding, relying on an RESP alone might not always be enough. It makes sense to look at savings options beyond your RESP.

When saving for school, RESPs (Registered Education Savings Plans) are hard to beat. But that doesn’t mean they’re perfect.

There are limitations on how much you can contribute. Plus, if your child doesn’t go on to post-secondary study, you might be forced to repay the grant money you received or incur tax penalties when you withdraw funds from your plan. That’s why reviewing additional ways to manage funds earmarked for higher education makes sense.

Here are four strategies worth considering.

1. Open an in-trust account

An in-trust account - a savings or investment account you open for the benefit of a minor child - offers several advantages.

First, it’s easy to understand and simple to set up through your financial institution, requiring minimal paperwork. Unlike an RESP, an in-trust account has no limit on the amount you can deposit. You’re able to contribute as much and as often as you like.

Next, there are potential tax advantages over saving money in a separate account in your own name.

While primary income like dividends and interest earned on your contributions will be attributed back to you for tax purposes, capital gains and secondary income (income from re-invested earnings) are taxable in the hands of your child. Because it’s likely they’ll have little or no other income, those earnings will be essentially tax-free. It also means if you have a reasonable time horizon to invest, growth-oriented vehicles that produce primarily capital gains can be particularly attractive for in-trust accounts.

One idea is to put $2,500 per year into an RESP to maximize the basic CESG, and then use an in-trust account for any additional deposits, giving you the best of both worlds.

That said, there is a key risk to recognize with this strategy. Once your child is no longer a minor, they will automatically gain control over the funds in the in-trust account. Instead of paying for education, if they’d rather buy a car or travel using the money you worked so diligently to save, they can.

2. Establish a formal trust

A formal trust is governed by a legal document, the trust deed, which spells out how the trust’s assets will be managed, as well as under what conditions the funds will be paid to the beneficiaries. Here’s a key benefit: you specify how the funds are to be used. So, unlike an in-trust account, with a formal trust arrangement you can be sure the savings will go towards paying for education or another purpose you designate.

Using a trust opens the door to some specific planning opportunities to build extra savings for your child’s education.

Make a prescribed rate loan

If you lend money to a trust for the benefit of your minor child, income earned over and above the interest expense of the loan can be taxed in your child’s hands. The prescribed rate, set quarterly by the Canada Revenue Agency, currently sits at 1%. Because the interest rate is fixed when the loan is made, today’s historically low rates make it an opportune time to consider this strategy.

There are strict rules that must be followed to realize the tax benefits of a prescribed rate loan strategy, so proper planning is essential. Your advisor can explain the details.

Pay out your company’s dividends

If you own a corporation, ensure some of its shares are held by a trust benefitting your child. Dividends can then be paid out from the trust to your child. That income is theirs for tax purposes. Again, because they’re unlikely to earn enough to owe anything, the strategy is a tax-efficient means of transferring wealth. In turn, your child can put the dividend income toward their educational expenses.

One caveat: make sure dividends are only paid to a child 18 or older, otherwise “kiddie tax” rules designed to prevent income splitting with minors kick in. Those rules will declare the dividends taxable at the top marginal rate, crimping the tax advantage.

Creating a formal trust can be costly, both in the initial set-up and ongoing administration, so first assess whether the dollars at stake justify both the expense and the added complexities involved.

3. Use a Tax Free Savings Account

A TFSA provides a tax-free source of funds you can use for any purpose, including funding your children’s education.

An important benefit of using a TFSA is its flexibility. If you need to take out some of the money you’ve put away for your child’s higher education before they graduate, perhaps to pay for tutoring or school trips, you can. Contribution room equaling the withdrawn amount is automatically restored the next year. Or, you could choose to one day use the savings for another purpose altogether, like helping your child with a down payment on a home.

Once your child turns 18 and is eligible to open their own TFSA, think about withdrawing funds from your TFSA to help fund theirs. Income earned in their TFSA won’t be attributed back to you. At the same time, you’ll free up contribution room for your own TFSA going forward.4

4. Look to life insurance

Life insurance isn’t just about financial protection. The right policy can also help you build savings.

Most permanent life insurance policies (whole and universal life) have a savings component that allows you to accumulate a cash value over time as you pay premiums. That cash value is tax-deferred and can eventually be tapped to pay for education.

How? One way is to transfer ownership of your policy to your child once they turn 18. Because the child becomes the new owner of the insurance, any withdrawals they make from the policy’s accumulated savings will be taxed at their lower marginal rate.

But before you act, think about your broader financial needs to ensure this strategy is appropriate.

No matter how you choose to save, save early

Regardless of the education savings strategy you use, it’s smart to start early. Here’s why.

Say you put $2,500 into an RESP when your child is born and every year afterwards. That amount allows you to maximize the basic CESG benefit of $500 a year ($7,200 lifetime). If your RESP earns a 5% annual rate of return, by the time your child turns 18 you’ll have nearly $80,000 saved for their education.

On the other hand, if you wait until they’re 10 years old to get started with the same annual contributions, the picture is quite different. Not only do you receive less CESG money, you lose much of the benefit of time and compounding. At an equivalent 5% yearly return, you’ll generate only a fraction of what’s possible by starting early. Even if you double your annual contributions to $5,000 to collect the full CESG entitlement, you’ll still come up short, accumulating less than $60,000 in the end.

We can help you make the best choice

The best defense against the rising cost of post-secondary school is a comprehensive education savings plan that considers all of your options.

Your financial advisor will work with you to create solutions that help you achieve your family’s education goals, without losing sight of your other financial priorities. Speak with us and discover why our advice makes a difference.