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Ontario|Investments & SecuritiesGeneral 264 Registered Education Savings Plans (RESP) & "In Trust For" Accounts While government funding for post secondary education remains frozen or is increasingly scaled back, tuition fees are expected to continue rising. The burden of educational financing has clearing shifted to the individual. Registered Education Savings Plans, often called RESPs, are designed to help people save for post secondary education costs. All RESPs are registered with the Government of Canada because they provide the contributor with tax benefits. In most cases, it is parents who invest in RESPs for the education of their children.
When evaluating the various options available for education savings, one should consider the issues of flexibility, control and taxation.
Two alternatives for education savings are the Registered Education Savings Plan (RESP) and the informal "in trust for" account.
- Registered Education Savings Plan (RESP)
The RESP offers investors the option of investing in two different plans, individual or family, depending on their situation.
An individual plan is ideal for an investor who intends to set up a plan for one beneficiary who may or may not be related to the investor. The family plan is well suited to those who are saving for multiple beneficiaries or who are concerned that the earnings in the plan may be forfeited in the event that a beneficiary does not attend a post-secondary institution. This choice gives them the flexibility of transferring the entire earnings in the plan to one or more beneficiaries who are related to the contributor by blood or adoption.
Whether an investor chooses an individual or family plan, contributions for RESP's are as follows: the annual contribution limit is $4,000 per beneficiary with a lifetime contribution limit of $42,000.
In order to assist families, and as an incentive to save for post secondary education, the Federal Government created the Canada Education Savings Grant, or CESG. Beneficiaries of a Registered Education Savings Plan may qualify to receive up to $400 free per year to a lifetime maximum of $7,200 through this Government of Canada Grant Programme. In addition to age restrictions, the beneficiary must also have a social insurance number and live in Canada in order to qualify for this government grant.
As the money is intended for post secondary education expenses, the contributor will have to repay the grant portion if the beneficiary does not attend a post secondary institution and another qualified beneficiary is not appointed.
If the beneficiary does not pursue a post secondary education, the contributor may withdraw the RESP earnings in cash. Doing this, however, would be disadvantageous because the contributor will be charged an additional 20% penalty tax in addition to his or her income tax rate. The better choice is to transfer the earnings in the RESP to an individual or spousal RRSP. The rules permit up to $50,000 in RESP earnings to be transferred to RRSP's provided there is contribution room.
The RESP contributor is free to select both domestic and international investments with no foreign content restrictions. Although the contributions to RESP's are not tax deductible, the earnings in the plan are allowed to compound tax free. It is the beneficiary who pays tax on the earnings on both the contributions and the grant payments, but not until the money is withdrawn from the plan to pay for college or university. This is advantageous because in most cases, the student's tax rate will be lower than the contributor's.
- Informal "in trust for" account
An alternative to the Registered Education Savings Plan is the informal "in trust for" account. The "in trust for" account can be a flexible savings vehicle because the funds can be used for any purpose that benefits the beneficiary. It is referred to as informal because no formal trust document is signed, but a beneficiary is designated. Accordingly, all savings and earnings must be used for the benefit of the beneficiary.
An informal "in trust for" account may be used by itself or in combination with an RESP. The RESP can be used to shelter earnings and qualify for the Federal Government grant, while an informal trust account can be used to make contributions beyond RESP limits. As is the case with RESPs, informal trust accounts allow for complete flexibility in selecting securities for the plan, without any restrictions on foreign content.
Unlike RESPs which allow earnings in the plan to compound tax free, informal trust accounts do not allow earnings to be tax sheltered. They allow instead for a contributor to divide some of the taxable income in the plan with the beneficiary. Interest and dividends are taxed in the contributor's hands, while capital gains are taxed in the hands of the beneficiary.
The subject of education funding and the most advantageous route to take, given your unique set of circumstances, should be discussed with a financial planning consultant.
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