After years of encouragement, stalling and procrastinating, I have submitted the final manuscript of my book on personal finance to my editor.
We call it Managing the Bull -- Detect and Deflect the Crap in Personal Finance.
When I realized it is already August and kids would be back to school before we know it, I figured the time is right to remind you about the most tax-efficient ways to put away money for your child's (or grandchild's) education. Here's an excerpt from the book:
Here are my top three basic ways to pay for post-secondary education.
Another option, which I endorse, is to make it clear to them from Day 1 that they will be paying for it themselves.
OK, never mind. Here are the other three:
1. Pay at the time the money is needed, with after-tax dollars. This is not the most efficient, and will only work if you plan to be making a lot of money when they start school, or if you are willing to sacrifice other things at that time.
2. Contribute to a Registered Education Savings Plan (RESP), starting as early as possible, which provides a government grant equal to 20 per cent of any annual contribution up to $2,500, plus tax sheltering on the investment income earned in the plan. It is also a way to set aside money that is clearly earmarked for education. More on the pros and cons later.
3. Put money away systematically in a non-registered investment account or a formal in-trust account, targeted for education. If it is the parent's or grandparent's money, then interest and dividends earned on this account must be declared each year on the tax return of the contributor. However, capital gains are claimable by the child.
On the other hand, any investment capital that comes from what the child earns, inherits or receives as "reasonable" gifts on special occasions creates investment income that is taxable to the child.
In-trust accounts are actually fraught with complications, and mistakes are commonly made. Before setting one up, speak at length with an investment adviser and a lawyer who are both familiar with the pitfalls and can create a trust agreement for you.
For pure education funding, I give the nod to the RESP for most families. The 20 per cent Canadian Education Savings Grant (CESG) on the first $2,500 per child per year means an extra $500 each year to invest. If it compounds at eight per cent a year, the grant alone can be worth over $18,000 when the child is 18. As of 2011, there is additional grant money available to contributors at low income levels.
The tax-sheltering on the growth also helps. The growth will be taxable to the child as the money is withdrawn while attending university or other post-secondary institution, but the child will generally be in a low tax bracket at that time, often paying no tax at all. The child also gets to use the tuition, education and textbook credits.
The original capital that you contribute can be withdrawn tax-free at any time.
For many people, the biggest advantage is the discipline and commitment such a plan provides. If you can afford $208.33 a month, you can maximize the CESG each year and have a substantial amount put aside for education by the time the child is ready to start school. That money will continue to earn investment income until withdrawn and should provide a good start on anything but an Ivy League university.
If you have more than one child, we suggest a family-plan RESP, which allows you to allocate the contributions and withdrawals to the different beneficiaries as needed.
If no beneficiary attends any type of post-secondary institution, the government grant has to be repaid, but not the earnings on it. The growth component must either be transferred to the contributor's RRSP (if contribution room exists) or withdrawn and be taxed.
But even in this case, the original contributed capital can be withdrawn tax-free, as there was no tax deduction provided for the deposit originally.
If you need more detail on any of these items, go to www.hrsdc.gc.ca/eng/learning/education_savings/index.shtml
David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).