Companion Advisor: General
Can you afford to send your children to college?
RESPs versus Trusts
According to Statistics Canada, the cost of university tuition in Canada increased by 152% between the years 1985 and 1995.
If you have a youngster who is contemplating university, tuition, rent, books and food could cost over $ 9,000 per year for 1998-99. (based on Canadian Federation of Students statistics for 1995-96 of $ 8,890 with annual inflation of 3.00%).
The 1998 Federal Budget included some changes to the Registered Education Savings Plan ( RESP) which may help you.
What is a RESP? This is savings plan which allows a subscriber to save money for the post-secondary education of a beneficiary.
Who can be a subscriber? Anyone, except a trust. If you are a grandparent, parent, uncle, aunt or family friend and wish to set up a RESP for a beneficiary, you can do so with your financial institution or your financial planner. Beginning in 1998, spouses may be joint subscribers to an RESP.
Who can be a beneficiary? The beneficiary can be anyone in a single-beneficiary RESP, including the subscriber. In a multi-beneficiary plan, where there is more than one beneficiary, each beneficiary has to be related to the subscriber by blood or adoption. Blood relation includes children, siblings, grandchildren and great-grandchildren but excludes the subscriber, his/her spouse, nephews and nieces.
What is the limit? There is a $ 4,000 per beneficiary per year for a maximum of 21 years, up to a lifetime maximum of $ 42,000 per beneficiary. Be careful that the $ 4,000 limit applies to each beneficiary and not each subscriber. So if uncle Joe and aunt Pat are both contributing to baby Robyn's RESP, the total cannot exceed $ 4,000 per year; otherwise, there is a penalty tax on overcontributions. The penalty tax is one percent per month on the amount in excess.
Can you skip a year? Yes, but you cannot make it up. In other words, there is no carry forward of the limit. You also have to close the RESP after 25 years. So, it's never too early to start your RESP.
What are the tax benefits? Unlike the Registered Retirement Savings Plan (RRSP), the contribution you make into a RESP is not tax deductible. However, the interest /dividends earned inside an RESP is not taxed until they are withdrawn. Over the time period when the RESP is set up to the time when it is withdrawn, this tax free compounding can be quite substantial.
What's new in the 1998 Federal Budget? A number of items, the most significant , perhaps, is the Canada Education Savings Grant (CESG).
What is the CESG? Introduced in the 1998 Federal Budget, this is an amount the government will pay into your RESP to help fund your children's education..
How much is the CESG? The CESG is 20% of the annual RESP contribution up to a maximum of $400 per year for beneficiaries 17 and under. The maximum lifetime CESG is $ 7,200. Contributions for children who turn 16 or 17 will be eligible for a CESG in that year only if there have been contributions of at least $ 300 per year for at least four years before the year in which the beneficiary turned 16. Alternatively, if total previous contributions have reached $ 4,000 before the year in which the beneficiary turned 16.
How can I get a CESG? The CESG is deposited directly into the RESP itself, but you need to submit a Social Insurance Number with the RESP application. The CESG is based on the RESP contribution.
What if I miss a RESP contribution for the year? Earlier, we said that the annual contribution limit for a RESP is $ 4,000, and that there is no carry forward if you don't make the contribution. For the CESG, the rules are more forgiving. Beginning with 1998, every child who is under the age of 18 will begin to accumulate CESG contribution room of $ 2,000 per year which translates to CESG of $ 400 per year. If you do not use up the $ 2000 CESG contribution room, the unused CESG room is automatically carried forward.
When does this all end? The RESP has to be collapsed in 25 years, or contributions can be refunded, or payments made for the beneficiary's post-education . There are different rules associated with each. The subscriber can withdraw contributions at any time without any tax consequences. But, if the the plan has received CESG, an amount equal to 20 percent of the contribution withdrawn must be repaid to the government (up to the maximum of CESG received), unless the withdrawal is for educational purposes. Payments made to the beneficiary for his/her education is decided by the subscriber. The subscriber can decide when and how much to pay out, and whether the payout is from capital or income made within the plan. There are restrictions that apply to educational courses before they qualify and the courses have to be post secondary level.
What if the beneficiary does not wish to pursue post secondary education? In a single beneficiary plan, the CESG must be repaid. If you have a multi-beneficiary RESP, the other beneficiary can use the money saved in the plan, a maximum of $ 7,200 CESG, and the excess CESG must be repaid.. Or, if all beneficiaries are not pursuing post secondary education, and the plan has been established for at least 10 years, a subscriber who is a Canadian resident can withdraw the accumulated income from the plan. This withdrawal will be included as income for that year, but the subscriber can transfer this accumulated income into his/her RRSP or a spousal RRSP, IF, there is RRSP contribution room. The maximum transfer is $ 40,000 per subscriber which goes up to $ 50,000 for 1999 and later years.
Are there other alternatives? Yes, you can consider a TRUST.
There are in-trust accounts, which are informal trusts, or you can set up a formal trust.
What is the difference? An in-trust account can be set up at most financial institutions whereas a formal trust is usually created by a legal document called a deed of trust. There is legal fees for setting up a formal trust, and accounting fees for filing trust returns and tax slips. The in-trust account is not a formal relationship whereas the that in a trust is formal.
We also have to be careful with where the funds for the trust comes from as this will lead to different tax treatment of the amount earned.
This article will not discuss the details of trusts and will focus on the advantages and disadvantages of RESPs versus TRUSTS.
The main advantage of a trust is that there is no restriction on using the funds only on post-secondary education. Your youngster may choose to travel around the world, and will not be restricted by the rules of the RESPs.
Contributions into RESPs or TRUSTS are not tax deductible, but more tax planning opportunities are available for TRUSTS depending on individual situations. You should consult with your tax advisor or accountant to review planning opportunities which may apply.
On the other hand, the money inside the trust, unlike the RESP contributions, cannot be refunded to the contributor.
Which is best for you? This depends on a number of considerations including the age of your child/beneficiary, the number of children/beneficiary, your financial situation, RRSP room, the intention of the beneficiaries of attending post-secondary education. I recommend that you discuss your needs with your financial planner and tax advisor and determine which is the best strategy.
Anne R. Chun is a Chartered Accountant and Certified Financial Planner practicing in Toronto. She is the author of Planning your Financial Future, a financial planning textbook, and also lectures at the University of Toronto, Ryerson and Seneca College.
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