By Troy Peart
In today’s increasingly demanding work force, a post secondary education has become a key determinate of job availability, advancement and income potential. Gone are the days when one could expect to start in the mail room of a large corporation and end up in upper management by virtue of their loyalty and hard work alone. Employers are now demanding increased educational requirements for even entry level positions that can be learned on the job. This trend has been occurring for some time now, and increasing numbers of individuals are seeking to become more competitive by attaining higher levels of education.
These higher levels of education do not come without their costs. It is quite common for a university student living away from home to spend over $50,000 for a four year program. These costs can be significantly higher if the program lasts longer than 4 years or if one decides to pursue a Masters or Ph.D. If this educational program is located outside of Canada these costs could be 5 or 10 times the Canadian costs. To top it all off, the costs are currently increasing at a rate much higher than the rate of inflation.
Funding for education can come from one of three sources: savings, a loan, employment during school (or between semesters) or any combination of these options. If none of these options are available a potential student is forced to either postpone or cancel their educational pursuits. For most parents I know, this would be an awful outcome since they all want their children to be “better off” than themselves. If the loan option is used, the repayment of these funds can often be quite challenging for an individual just starting a new career.
This brings me to the topic of this months discussion: Registered Education Savings Plans (RESPs). RESPs can be an effective way of saving for a child’s education. With the addition of the federal government sponsored Canada Education Savings Grant (CESG) and Canada Learning Bond (CLB), RESPs have become even more attractive.
Basically, there are two types of RESP plans: pooled and individual. In pooled plans, the subscriber selects a preset savings plan, has no choice of investment vehicles, and pay outs are pooled amongst beneficiaries through scholarships. Individual plans are less restrictive than pooled plans. They allow the subscriber to determine the deposit and pay out schedules in addition to the investment options.
Contributions to RESPs are limited to a lifetime maximum of $50,000 per child and can be made all in one year or over several years. These contributions are not tax-deductible (like RRSPs) but the income within the plan is tax deferred. The beneficiary then pays tax on the income as it is withdrawn if it is used to pay for the cost of a qualifying educational program. The contributed capital is not taxed and can be withdrawn at any time with no tax consequences. The maximum life span of an RESP is 26 years after which time it must expire and the assets de-registered. Contributions can only be made within the first 21 years of the plan.
In addition to these benefits, the federal government contributes 20% of the subscriber’s annual contributions up to a maximum of $500 per year and $7,200 over the lifetime of the RESP. These government contributions are referred to as Canadian Education Savings Grants or CESGs. If any CESG goes unused for one year, the eligibility can be carried forward and the grant in a future year could be up to a maximum of $1000. This is the even the case if a child did not have an RESP previously. Every child accumulates grant eligibility either from birth or 1998, whichever is later. To further encourage low and middle income families to save for their children’s education, the Federal Government has increased the matching rate to 40% and 30% respectively beginning in 2005. Only beneficiaries under the age of 18 are eligible for CESGs.
For families that qualify for the National Benefit Supplement (generally families with adjusted net incomes under $37,178), the Federal government has introduced the Canada Learning Bond (CLB). The government pays an initial CLB of $500 to eligible children born after January 1, 2004 and subsequent installments of $100 will be available for children each year of eligibility until the age 15.
If an RESP is de-registered due to expiration or because the beneficiary is not pursuing qualifying studies, the income accrued is subject to a 20% penalty and the remainder is taxed as income for that year. This income is then taxed in the hands of the contributor rather the beneficiary. One way to avoid this tax (which can be quite substantial), is to transfer the remaining income into one’s RRSP. This only works if one has enough contribution room and if the growth is less than the current transfer limit of $50,000.
When used correctly, RESPs are an excellent way to fund a child’s education. Despite this fact, RESPs are not the only method of educational funding and one’s specific situation should be evaluated to see if this option is appropriate. Professional advice should be consulted to ensure one’s RESPs are suitable and administered in accordance with their goals and objectives.
Troy Peart B.B.A., CFP, CFA can be contacted at troypeart@shaw.ca. Your questions, comments or suggestions for future articles are encouraged.
