Planning For Education
Now that the school year has come around again, you’ve probably spent some thinking about how to fund your child’s (or children’s) education without indebting the whole family to the government and to the banks. The good news is, from a tax and investment perspective, there has never been a better year to bring education funding into your financial plan.
Using a combination of two widely available investment programs, you can put your family ahead of the game: the Registered Educations Savings Plan (RESP) and the Tax-free savings account (TFSA). The RESP is a tax-deferred savings account that allows you to save money for your child’s education (or the education of an unrelated child whose educational needs you are looking out for) without worrying about paying tax on the earned interest or dividends. When you contribute to an RESP, unlike the similarly named RRSP, the contributions are not tax deductible – so keep in mind that this strategy won’t get you a refund cheque. What you will get (assuming you’ve taken advantage of this program when the child beneficiary is young enough) is a partially matched government grant that will add potentially hefty contributions to the savings plan.
When you contribute to an RESP, you will receive a 20% matching contribution in the form of the Canada Education Savings Grant (CESG). The maximum CESG amount for each year is $500 (With a lifetime maximum of $7200). Using this strategy, it wouldn’t be practical to deposit more than $2500 into the RESP on a yearly basis, since you won’t get any more matching dollars over that amount. The grant, along with your RESP contributions, will grow on a tax-free basis. When the RESP beneficiary withdraws the money to pay for educational expenses, the income is taxed in the young one’s hands. Considering that most students have very low annual taxable income, and considering the tax deductions and credits available for most full-time students, the amount of tax they should expect to pay after withdrawing RESP money is usually fairly low – if anything at all.
The Tax Free Savings Account is another useful tool for stashing away long-term education savings. Like the RESP, investment growth inside the TFSA is not taxed while it remains invested. Unlike the RESP, there is no government matching. That’s okay – the TFSA has a special perk which more than makes up for that. When funds are withdrawn from the TFSA, none of the growth is taxed. At all.
Each year, every Canadian over the age of 18 is allowed to make a flat $5000 contribution into a TFSA. In the case of a two-parent household, it’s not unusual for the higher income earner to make all of the contributions (i.e., deposit $5000 into his or her own account, then deposit another $5000 into the account of the lower income-earner), to get a nice break on taxable investment growth. Which means that $10,000 of savings per year can grow tax-free in every household.
Now here’s where the fun part starts. You can contribute $2500 each year to your child’s RESP (and pick up the $500 grant), and then deposit any extra available savings (up to $5000) in your TFSA. When your bright, young prodigy hits 18, you can then withdraw the funds tax-free from your own TFSA, and deposit it into a TFSA set up in the student’s name. The student can then withdraw the funds as necessary, pay no tax on the withdrawals and, at the same time, you have freed up room to make TFSA contributions for your own long-term savings.
Being financially fit includes giving your children a headstart on their education, helping them understand the true value of money and making sure your family doesn’t get saddled with debt for that academic pursuit.
Many Blessings,
Andray Domise
Independent Financial Advisor
Change your life one dollar at a time, with REAL help for building wealth and reducing debt:
http://www.andraydomise.com
Education Savings Plan FAQ:
Question: Registered Education Savings Plan?
How much does a provider or agent (or whatever they are called) make? I was told by someone that they make up to 1500 dollars on every child they register.
Answer: Depends on the company and payment structure, but usually its based on the underlying investments. On average around 2-3%. But that isnt a direct expense to you. It is usually paid to them by the company they work with/for.
Question: What is the best type of long term savings plan to save for my children’s education from middle school up?
I plan on having my children attend private middle school and up and want to start saving. We live in Maryland.
Answer: Your best bet is to talk to a financial adviser that can tell you what is best for your individual situation. As far as a starting point, either a 529 plan or Coverdell Savings account.
Question: What is the best college savings plan for me?
My savings account is with ING and I can’t complaint. Yet, my plan is to work to get a master’s degree sometime around 2010. I’m doing my BS in education.
Answer: Since you will need the money relatively quickly, you should stick to a safe and conservative investment vehicle. I would move money for your education to a 1 year CD.
Question: Do you have or do you plan to start a savings account for your child’s college education?
And did your parents have one for you?
Answer: Not yet and I don’t know if we will. My parents didn’t have one for me, but they still helped for part of my college and the rest I have student loans for. There is a part of me that doesn’t think it’s a parents responsibility at that point. My husband parent’s had an interesting deal with him. They didn’t pay for anything until he finished, but now they are paying back his student loans.
Question: What are some options for saving for my childs college education?
My child is 11. I am a single parent. Should I buy into my states college credit savings plan? What if my child ends up with a sports scholarship, would I lose those college credits? Should I buy bonds instead?
Answer: There are many ways that people save and fun their child’s education. Two popular ones are state sponsored college plans, and 529 Plans.
You would have to read through the specifics on your state sponsored plan as it will have provisions for scholarships and also if the student decided to attend school out of state.
A 529 plan gives you more flexibility. 529 refers to the lines in tax code that say – for money invested in the plan, any growth is available to you tax free when the funds are used for education. There is no provision as to what state the funds are used in, and there is a provision included that deals specifically with scholarships and how to withdraw equal parts from the plan to offset those. Many financial services companies carry these plans – an example is American Funds, also Oppenheimer. The plan has professionally managed portfolios and options that can automatically move to safety as the student gets closer to college. See your financial advisor who can specifically explain the plan to you.
Question: How are you saving for your child’s college education? Specific Plans, etc.?
I’m looking into beginning college savings plans and was wondering what plans you are utilizing to save for your child. We are looking into a UPromise account which is a dressed up 529 account but are there other plans that are as effective?
Answer: We put aside $20 dollars a week for our daughter and at every $500 we put in in a 12 mo. CD. We started when she was born so she’ll have a good start for college between what we’ve saved and the intrest it draws.
Question: What is a tax-free savings account in Canada?
I saw an ad at my bank about opening up a tax-free savings account. That surprised me, because how is the government supposed to know how much you have in your bank account? I never saw that anywhere on the tax forms. I thought the government only taxed you based on how much you make per year. What does a tax-free account mean and should I get one?
Answer: If you have a bank account and earn interest on your money, that interest is taxable. So if you have a lot of money in the account and make, let’s say $200 in interest, that $200 is taxable. The government will know how much you made in interest because the Bank will tell them and issue you (and the Gov’t) a tax form indicating how much money you made in that account.
A Tax Free Savings account is one where the money you earn on your savings (the interest) is NOT taxed; you get to keep it all. You will likely have a maximum of $5000 that you can put into such an account each year (which is more than most people need) and all the interest grows without being taxed. The bank will register that account with the government so they know there will be no tax owing on the interest you make. It was established to help encourage people to save for retirement.
Question: I have vested Restricted Stock Units. Is it smart to transfer them (in kind) to a tax free savings account?
I’ll probably sell them in 3 years or so and I expect that they will increase in value.
Answer: If you transfer any property into a TFSA, you will be deemed to have sold them at whatever their fair market value is on the date of transfer. In the case of stock, this would normally result in you having to report a capital gain. You would not be able to claim a loss as the TFSA would be considered an affiliated person, and the transaction would fall under the superficial loss rules.
Is it smart? Well, essentially, you would be stopping any taxes that will accrue on gains after the transfer. In addition, you would no longer be taxed on any dividends that are paid from the stock as these amounts would be paid to your TFSA. That last would not necessarily be an advantage due to you having lost the ability to use the dividend tax credit.
Hope that helped. You’ve got a decision to make, and a few things to consider before you do it.