Most parents hope their children will pursue higher education – and for good reason. A post-secondary education can prepare your child for a fulfilling career, lead to enhanced earnings potential and, ultimately, steer them on the path to a successful and rewarding life. However, if adequate savings are not in place for post-secondary education, your child could graduate with the added stress of carrying significant student debt before they’ve even secured their first job.
In the early 1990s, average undergraduate tuition fees in Canada were $1,4641 . Today, these fees have risen dramatically to an average of $6,8382 – far outpacing inflation. And, in today’s competitive job market many young people are choosing to remain in school to earn a second degree, making post-secondary education expenses even higher. According to the Canadian Federation of Students, Canadian post-secondary students graduate with an average student debt of $30,0003.
With these costs in mind, education planning should be an important component of your overall family wealth management plan. Beginning a dedicated education savings plan while your children are still young helps ensure you have the funds necessary when they begin their post-secondary studies.
Education savings options
There are many ways to fund your children’s higher education. What’s right for your situation depends on many factors, including: your disposable income; whether financial assistance will be provided by other family members, such as grandparents; the ages and number of children involved; the options for your savings if your child doesn’t pursue a formal post-secondary education program; and whether you want your children to have control over the assets when they reach the age of majority4.
Registered Education Savings Plans
Many parents begin saving for their children’s post-secondary education by establishing a Registered Education Savings Plan (“RESP”). While your RESP contributions are not tax deductible, the funds grow tax-deferred inside the plan and are eligible for additional contributions from the Federal government through the Canada Education Savings Grant (“CESG”). Over the life of the RESP, parents can contribute up to $50,000 per child, and each child qualifies for up to $7,200 in CESGs. As well, RESPs may be eligible for additional educational grants through other Federal and provincial programs, where applicable5.
When RESP funds are used to pay for education expenses, the accumulated income (including CESGs) is taxed in your child’s hands, resulting in little or no tax if withdrawn over a few years because of the basic personal exemption and the tuition tax credit.
Your RESP contributions can be returned to you (or your child) tax-free at any time. However, a withdrawal of the RESP contributions will require repayment of the CESG if your child is not attending a qualifying post-secondary educational program.
While an RESP is a great starting point, you may want to consider additional funding options to supplement your children’s education expenses.
One of the simplest ways to supplement RESP savings is by opening a non-registered account specifically earmarked for your children’s post-secondary education savings. The account will not be subject to any special rules or restrictions concerning contribution amounts or their frequency, and you maintain control over the timing of contributions and use of the funds, even when your children reach the age of majority. You can withdraw money to fund your children’s post-secondary education tuition fees or other needs.
The downside of saving for your children’s education with a non-registered account is that all income and capital gains are taxed in your hands, causing tax inefficiencies.
Tax-Free Savings Account
Another option to consider is the Tax-Free Savings Account (“TFSA”). Canadians can contribute $6,000 annually to a TFSA and unused TFSA contribution room is carried forward for use in future years. While your contributions to a TFSA are not tax deductible for income tax purposes, your savings grow taxfree and you can withdraw the money when it comes time to finance your children’s post-secondary education without attracting any taxes.
Additionally, once they reach the age of majority, you can give money to your children who can then use these funds to make a contribution to their own TFSA. While you can’t contribute directly to someone else’s TFSA, this strategy allows you to help your adult children build assets, without having to worry about any income being attributed back to you. However, they will have full control over how their TFSA funds are used and whether they are withdrawn.
A formal trust may be appropriate if you want to contribute a large amount of money in a tax effective manner, or where it is important that a trustee has flexibility and discretion over the management of the trust assets. A formal trust requires that there be a settlor, contributed property, a trustee and one or more beneficiaries. The person, usually a parent (or grandparent), who creates the trust and initially contributes the assets is the settlor. The trustee is responsible for choosing the investments and for the overall administration of the trust, including distributing funds as governed by the terms of the trust. For an educational trust, the beneficiary – a child or children – is(are) the individual(s) who will benefit from the trust by receiving payments when they begin their post-secondary studies. The trust deed specifies how the trustee is to manage the trust assets, names the beneficiaries and details when the trust’s income and capital can be paid to the beneficiaries or the educational institution.
While there are costs associated with establishing and administering a trust, parents (or grandparents) have peace of mind knowing that the money in the trust will be used for the purpose for which it was intended. For more information, including education funding strategies involving the current low prescribed interest rates on family loans, ask your BMO financial professional for a copy of our publication, Tax Planning Involving Family Trusts.
Previously, if you were an incorporated professional or had an incorporated family business and had accumulated funds in your corporate account, you were able to pay out company dividends to split income with other family members, including your children aged 18 or over, provided they owned shares of your company either directly or indirectly.
However, in light of the recent expansion of these tax on split income or “TOSI” rules, effective for the 2018 and subsequent taxation years, any shareholder of a private corporation who does not meet specific exceptions will now be subject to these expanded TOSI rules, which will apply the highest marginal tax rate to income, including dividends, paid to them directly or through a family trust. For more information, please ask your BMO financial professional for a copy of our publication, Tax Changes Affecting Private Corporations: Tax on Split Income (“TOSI”).
As a result, the feasibility of this strategy to pay dividends to your children to help fund their education will be largely curtailed, unless your children (aged 18 or over) have made a substantial labour contribution (generally an average of at least 20 hours per week) to the business during the year, or during any five previous years. Instead, you may wish to consider alternative compensation structures such as wages paid to family members, since wages earned by family members are not subject to these TOSI rules. However, in order to ensure wages paid are deductible to the private corporation for tax purposes, the wage expense must be reasonable in the circumstances.
For further assistance, please consult with your professional tax advisor as these rules are complex.
If you’ve maximized your RESP contributions and have a need for permanent life insurance protection, this may be another way to help save for your child’s post-secondary education. Using life insurance gives you the ability to tap into the excess cash value in certain types of policies.
With this strategy, an application is made for a life insurance policy naming yourself as the owner and your child as the individual whose life is being insured. The beneficiary – the individual who will receive the death benefit – can be the owner of the policy or someone else. For example, grandparents wanting to help fund their grandchild’s education could purchase an insurance policy insuring their grandchild, and then name their child – the grandchild’s parent – as the policy beneficiary.
To build the cash value within the life insurance policy, a supplement to the required monthly premium is made by depositing additional payments (within set limits) which grow tax deferred inside the policy during the accumulation period. When your child reaches the age of majority, ownership of the policy can be transferred tax-free to your child. As the new owner, your child can withdraw the excess cash value that has accumulated to pay for post-secondary education costs or other expenses. Any resulting gains will be taxed in the hands of your child, who will presumably be in a lower tax bracket than you.
It is important to note that this strategy is not suitable for everyone as you may lose control over the money and other policy rights, such as beneficiary designations, after you transfer title to your children, as well as issues caused by excess withdrawals impacting the coverage offered by the contract.
Choosing the best option
The actual cost of a higher education varies with the school chosen, the degree(s) sought and the discipline selected. While these costs continue to rise, a comprehensive education savings strategy, and an early start, will help ensure your children get the education they want and deserve.
Your BMO financial professional can prepare an in-depth education analysis that details the anticipated costs of educating your children and your ability to fund these costs. This information will assist you in developing a personalized education savings strategy that complements your overall wealth management plan, and may include one or more of the savings options discussed in this article.
For more information, speak with your BMO financial professional.
1Statistics Canada, “The Daily,” September 1, 2005.
2Statistics Canada, “Tuition fees for degree programs,” 2018/2019.
3The Canadian Federation of Students, “Public Education for the Public Good,” 2014.
4Age 18 or 19, depending on your province of residence.
5Additional Educational grant programs include the Canada Learning Bond, Quebec Education Savings Incentive, and British Columbia Training and Education Savings Grant (“BCTES”)
BMO Private Wealth provides this publication for informational purposes only and it is not and should not be construed as professional advice to any individual. The information contained in this publication is based on material believed to be reliable at the time of publication, but BMO Private Wealth cannot guarantee the information is accurate or complete. Individuals should contact their BMO representative for professional advice regarding their personal circumstances and/or financial position. The comments included in this publication are not intended to be a definitive analysis of tax applicability or trust and estates law. The comments are general in nature and professional advice regarding an individual’s particular tax position should be obtained in respect of any person’s specific circumstances.
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