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can be withdrawn any time free of tax because there isn't any tax break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,
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eventually withdrawn to pay for the child's post-secondary education the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
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can still be withdrawn tax free.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growth are tax free until the funds are withdrawn for the child.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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