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The Money Management Newsletter: RESP - Education Savings
An educational RESP for rising costs - Which do you choose?

We are all well aware that the cost of post-secondary education keeps increasing. For parents or grandparents who wish to assist in financing a child's education, one of the key problems faced is choosing the best investment vehicle to achieve the desired goal. For many the dilemma is between choosing an RESP (Registered Education Savings Plan) or an "In Trust" account. Ideally the best plan is one where the savings can grow as quickly as possible without any tax liabilities being incurred by the donors and which permits as much flexibility as possible with respect to the use of the funds saved. As usual there is no perfect vehicle as both RESPs and "In Trust" accounts have different pro's and con's.

An RESP can be set up with one of the several scholarship funds available or if more control over the investment selection is desired individual plans are offered by many mutual fund companies where you can decide exactly how your funds are to be allocated. For each child the maximum annual contribution is $4,000 with a total lifetime contribution limit of $42,000. The total CONTRIBUTIONS can be withdrawn any time free of tax because there isn't any tax break for them when they're made. Any GROWTH within the plan whether it be interest, dividends or capital gains will accumulate free of tax to the donor. When the funds are eventually withdrawn to pay for the child's post-secondary education the GROWTH portion is taxed in the child's hands which should be at a lower marginal rate than the donor's. If the child does not attend a post-secondary education by age 21 and the plan has been in operation for at least 10 years the growth portion can be transferred to the donor's or the donors spouse's RRSP ($40,000 total limit) provided there is sufficient RRSP room available. The remaining growth can be taken into the donor's income at regular tax rates plus an additional 20% tax. The original contributions can still be withdrawn tax free. I like the fact that the donor maintains control of an individual plan..not the child and that all forms of income growth are tax free until the funds are withdrawn for the child. Problems can arise however if maximum contributions are made early in the child's life and the fund grows substantially. The growth may be far more than required for the child's or a substituted child's education and if no RRSP room is available the donor's will have to pay the price to take the extra growth into their income.

An "In trust" arrangement involves opening an investment account in a person's name in trust for the child. There are no limits on the amount of funds that can be contributed to such an account and all funds can be used at any time for any purpose for the child's benefit other than food, clothing and shelter. Unlike RESPs the GROWTH in the "in trust" account is subject to tax annually...there is no deferral. Interest and dividend income is taxable in the hands of the donor while capital gains are taxed in the hands of the child. Interest earned on interest is taxed in the hands of the child (the same goes for dividends). Any income earned from Child Tax Benefit contributions is taxable in the child's hands. Other drawbacks to this type of account are that at age 18 the child can assume full control of the account (since it's in trust for him/her) and use if for any purpose. Also since the account is an informal trust (there isn't a formal trust deed) Revenue Canada could consider the arrangement a revocable trust and attribute any capital gains to t! he donor rather than the child. To protect from this a prior Revenue Canada opinion may be required or donors could use the format of irrevocable gifts from one person to another to be held in trust for the child so there is a clear separation between donor and child by the intermediary person acting as trustee. Built up capital gains in these accounts have to be managed as discussed below to prevent a substantial tax liability for the child when the fund is eventually collapsed.

A possible course of action is to use both types of plans for ultimate flexibility. Build a balanced portfolio and place in an RESP the conservative portion using investments that produce interest or dividend income. This type of income will not be attributable to the donor but taxed in the child's hands when withdrawn. The donor will always control the capital and since only part of the overall savings will be invested in the RESP the likelihood of penalties to the donor is reduced if not all savings are used for the child's education. Place the more aggressive portion of the portfolio in an "in trust" account that uses only growth equity funds so that capital gains are generated which again are taxed in the child's hands. Whenever the built up gains reach around $8,600 trigger them so they are offset by the child's basic personal exemption of $6,456 (only 75% of the gain is taxable). In this way when the funds are eventually withdrawn the cost base of the account will be! very close to the market value and there won't be any tax liability. Using this combination the RESP portion reduces the amount of capital the child could control at age 18 while the "in trust" portion will provide the flexibility lacking in the RESP.

Rob Whipp is the Editor of the Fiscal Agents Money Management Newsletter and can be reached at (905) 844-7700.

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25 Lakeshore Road, Oakville, On L6K 1C6.
(905) 844-7700

 





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RESP -
Education Savings
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An educational RESP for rising costs - Which do you choose?

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