RESP the cornerstone of education funding

(August 10, 2004) Back-to-school season is rapidly approaching and while parents may be looking forward to having the kids out of the house, many are sending their kids off to college or university for the first time — and facing the bills.

Fortunately for those with an astute financial advisor, the next four years of higher learning are already partly paid for.

“The knowledge about RESPs has gone up tremendously over the last five or six years,” says Dave Ablett, manager of advanced financial planning support for Investors Group. “When one of our consultants is speaking to a family with small children, the number one thing we’d say they should do is get the RESP started. We think the RESP should be the foundation for education savings.”

While the contributions are not tax deductible, any money earned within the RESP is. On top of that, there is the Canadian Education Savings Grant (CESG), which offers a 20% bonus on top of the first $2,000 the parents contribute.

Starting in 2005, the CESG gets even better for lower income clients, with those earnings less than $35,000 a year getting a 40% grant on the first $500, bringing the maximum grant to $500. Those families earning between $35,000 and $70,000 get a 30% top up on the first $500, bringing their maximum grant to $450 per year.

“You can put up to $4,000 a year into an RESP for each child, which admittedly could be hard for a family to put that much in, especially when you’re dealing in effect with after-tax dollars,” he says. “We certainly would recommend that they try to put in the $2,000 to take maximum advantage of those grants.”

If a child decides not to go to school, the parents may name another child as beneficiary of the plan. Any CESG funds in the first child’s RESP in excess of the $7,200 maximum benefit must be refunded, but the investment proceeds earned over the years may be kept.

As far as downsides, RESPs carry few. If an only child decides not to attend a post-secondary institution, the parents could face a tax hit on any accumulated earnings in the plan, with the funds counting as income for the subscriber. There’s also a 20% surtax slapped on the proceeds as well.

There is an escape, however, if the parents have sufficient unused contribution room in their RRSP. The funds which have accumulated tax-free in the RESP can be rolled into an RRSP free of penalty.

“The only time limit in effect is that the RESP cannot be in existence for more than 25 years from when it starts,” says Ablett. “If the parents set up the RESP when the child was three years of age, no final decision would have to be made until the child was 28.”

The options for withdrawing funds from an RESP are rather accommodating as well. Ablett says there is one restriction of note for RESPs opened after 1998, which dictates that no more than $5,000 total of CESG amounts and any of the RESP’s earnings to date can be taken out — a distribution known as an educational assistance payment (EAP) — in the first 13 weeks of an educational program. There is no such restriction on the withdrawal of the actual RESP contribution, however.

After 13 weeks, the entire EAP amount can be accessed if so desired, but it would be wise to budget the funds over the course of the school program, since withdrawn funds are taxed as regular income in the hands of the student.

“Because the income is taxable in the hands of the child and not the parents, it’s very likely that no tax will have to be paid because the child likely has little or no income,” says Ablett. “And they’ve got their tuition and education tax credits to use.”

Of course, all funds must be withdrawn by the end of the 25-year limit.

But the RESP can be the cornerstone of a much larger plan.

“There are a couple other ideas, if the parents want to put additional money away,” he says. “A lot of parents set up in trust accounts. What they would like is to have the money taxed in the hands of the child, but they want to control the child’s access to the money.”

He suggests investing the government’s Child Tax Credit in a non-registered account in the child’s name, which will leave any gains taxable in the hands of that child, achieving some income splitting.

Ablett points out that when the child turns 18, however, they have the legal right to use that money for whatever they see fit, be that a university education, or a trip to Europe.

“If they want total control, they’ll put the account in their own name, but then they will pay the tax on all the investment income,” he says. “If they set the account up in the name of the child, then any interest or dividends will be taxed to the parent, but any capital gains will be taxed to the child.”

Another option for parents is to provide for their children’s education through their life insurance and disability insurance policies. A testamentary trust is another strategy for parents to pay for education, with the child receiving the balance of the trust after school has been completed.

“A testamentary trust can be written in a way to meet the exact wishes of the parents,” says Ablett.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(08/10/04)

Steven Lamb