Options to save for education
When it comes to saving money for your child or grandchild’s education, there are a lot of options to consider.
Registered Education Savings Plan (RESPs)
Typically Registered Education Savings Plans (RESPs) are one of the most popular vehicles. The main reason for the popularity of RESPs is that the government introduced something called the Canada Education Savings Grant (CESG) where the government will invest 20 cents for every dollar invested into the RESP per individual. From 1998 to 2006, the maximum CESG was $400 per year per child. In 2007, the government increased the annual CESG maximum to $500 per child. The one key stipulation to the CESG is that the child must have a Social Insurance Number (SIN).
Are RESPs the best way to save for your children’s education? Personally, I like RESPs and as a father of 4 boys, I own a family plan for my kids. It’s really tough to overlook the 20% government matching. One of the criticisms of RESPs it they must be used for the purpose of education so it is important to know that RESPs are not the only way to invest for future education.
Pooled RESPs are sometimes known as scholarship trusts or education trusts. Contributing to a pooled plan means that you will purchase units into a pool of investors. Typically the pooled programs will only invest in fixed income securities. If you were to buy units of these pooled RESPs, you would have no control over the investments.
You have to really be careful about the details of these contracts especially when it comes to fees. According to Perry Quinton, Investor Education Officer of the Ontario Securities Commission, “You can expect to pay enrollment fees, administration and management fees, sales incentive fees, trustee fees, custodian fees and transaction costs.”
I prefer a family or individual plan because I have much more flexibility all around.
Obviously you can save for a child’s education just through regular savings. The advantage to this is that there are NO restrictions in terms of minimums, maximums, investment choices, etc. Any investments will be held in the name of the adult (parent, grandparent, uncle, guardian, etc), which means the adult really owns the money and therefore is responsible for the tax. You can save for anything this way, not just for an education plan for your kids.
Informal trust accounts are similar to a regular savings account except that it is owned ‘in-trust’ by the parent, grandparent or guardian on behalf of the child. It is considered informal simply because there are no formal trust documents signed.
The benefit of an in-trust account is that some of the tax may be taxable to the child depending on the type of income the investments produce. This is beneficial because the child typically has no income and therefore pays no tax.
Any capital gains generated by the investment are taxed in the child’s name. Dividends and capital gains are taxed in the parents’ name. Therefore, the ‘in-trust’ account favours growth investments like equities.
If you are investing money into an in-trust account, the deposits are irrevocable. Meaning the funds are owned by the child. If the parent decides to take the money out and use the funds, he or she will have to pay the tax on the capital gains.
Similar to savings accounts the money saved can be used for any purpose and not just for education. For Example, this money cold be used for a myriad of options like buying a car, traveling, putting a down payment on a house, or maybe to start a business, etc.
Although In-trust accounts are quite popular, there is a place for caution. Read my previous post on why you should be cautious about in-trust accounts.
A formal trust differs from an informal trust in that a lawyer must draw up forms for signature. The trust specifies how monies can be invested, who the beneficiaries of the trust are and how the money can be used. The taxation of investments is similar to the informal trust. The biggest advantage is the ability to dictate when and how the money can be used. However, There are fees to set up formal trusts compared to the other options.
RRSPs – Lifelong Learning Plan
The government introduced new legislation that you can withdraw money from your RRSP for the purpose of education. The Lifelong Learning Plan allows an individual to withdraw up to $10,000 per year up to a maximum of $20,000 from the RRSP over a four-year period. The withdrawal must be paid back over a 10-year period otherwise it will be added to your income and then taxed. For more information, you can search the government website www.ccra.gc.ca.
Life insurance is another way to save for a child’s education. Given all of the other options, the popularity of using life insurance for education funds has diminished dramatically. Personally, I think there are better ways for education savings but it’s an option none-the-less.