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Ask the Pro - Registered Education Savings Plans & Family Finances
Steve has been in the financial services industry for more than 18 years and his expertise incorporates private and public accounting, auditing, tax planning, and personal and corporate consulting.
Steve is the director of Bentley Financial, a financial services firm that was launched in 2003. Feel free to download the Bentley Financial Focal Point on Registered Education Savings Plans or contact Steve from Bentley Financial via the form below.
Alternative Ways to Contact Steve:
Telephone: 519-404-4864 or 1 888 88 BENTLEY
Email Address: info@bentleyfinancial.ca
Website: www.bentleyfinancial.ca
Archive
Questions & Answers - 2008
Browse the Q & A below or ask our RESP & Family Finances Pro
Steve Bentley your own question! The list of questions and answers will be updated regularly.
1. January 2009: We have a limited amount of funds to invest this RRSP season. Should we contribute to an RESP or an RRSP?
2. February 2009: With the release of the brand new Tax Free Savings Account (TFSA) this year, is it a good tool to use for set up savings accounts our children’s education? We hear it is only for people over age 18.
3. March 2009: I had a client send me a rather simple yet involved question. Is life insurance for small children sensible or silly?
4. April 2009: With the new Tax Free Savings Account (TFSA), are there any new tax benefits in contributing to this type of account as part of saving for our childrens’ education? Is it best to save using a Registered Education Savings Account (RESP) or should we use both?
5. May 2009: With the current economic recession, money is tight. How do we teach kids about what a recession is, explain what’s happening, and the impact it is having on our family?
Answer: Should you sock money away in registered investments for your retirement or use it to save for a child's post-secondary education, thus sparing you that expense later? There is no universal answer to this debate as there are a myriad of factors and assumptions involved. Let's look at the considerations you should take into account.
First of all, the main benefits of RRSPs are twofold:
- an immediate tax deduction resulting in a tax refund; and
- tax deferred growth until the funds are withdrawn from the plan.
The additional benefit with RESPs is the Canada Education Savings Grants (CESG), which equal 20% of the first $2,500 contribution per year, per child under the age of 18 (low and middle-income families are eligible for larger grants). If you contribute $2,000 to an RESP for 18 years, you can collect CESG each year for a total of $7,200 after 18 years. If annual CESGs were invested at 6% per year inside a tax-deferred RESP, after 18 years, the CESGs alone will be worth $13,000.
Since no grants are provided for RRSP contributions, does this tip the scales in favour of RESPs? Not so fast.
The primary benefit of the RRSP is a tax refund. Assume a $2,000 annual RRSP contribution is made each year for 18 years. If you are in a 40% marginal tax rate, you would receive $800 in annual tax refunds. If these refunds were invested in a long-term, non-registered equity fund that grew by 6% per year, the value after 18 years would be approximately $26,200. Subtracting capital gains tax of 20% on the growth would net you nearly $23,850.
Things get complicated when you take into account the taxation of withdrawals; both plans are treated differently and it depends on a number of assumptions.
With an RESP, contributions can be withdrawn tax-free, but the growth and CESGs are taxable to the student at his or her marginal tax rate. If the student earns income from a job while in school, that rate may be 25%. Alternatively, if the student has no income while studying, he or she may be able to shelter all RESP growth and CESG withdrawals through the use of personal, tuition, education and textbook tax credits.
With an RRSP, the time horizon for compound growth is typically much longer than a RESP. The longer the funds stay invested on a tax-deferred basis, the greater their advantage over RESPs.
All things considered, perhaps the best plan is both plans. It would be worthwhile to consider how this specifically applies to your own situation. For more information, please contact Bentley Financial by email at info@bentleyfinancial.ca or simply call us at 519-404-4864 (1 888 88 BENTLEY toll free).
Answer: The new Tax Free Savings Account (TFSA) may be a good tool for assisting in saving for your children’s education. Do you think you can save enough to give your child a decent education? The following highlights how a TFSA can be a good option to meet your child’s expenses. A TFSA can be a good savings solution for parents planning for their children’s education. Following are some salient points.
- Canadians aged 18 and older can save up to $5,000 every year in a TFSA. Due to the age restriction children below the age 18 are not eligible to open a TFSA account.
- Contributions to a TFSA are not tax deductible but investment income including capital gains earned in a TFSA are tax –free.
- Withdrawals from the TFSA are not taxable and the account holder can withdraw funds at any time. Flexible contribution rules make deposits and withdrawals easy.
- The money from the account can be withdrawn for any purpose. Even if a couple primarily wanted to save for their child’s education, they still may use the money to meet other needs as well.
- The 2007 Federal Budget amended the RESP on the following lines which is very beneficial for Canadian parents:
- The $4,000 limit on annual RESP contributions was removed.
- The lifetime RESP contribution limit was increased to $50,000 from $42,000. Both these changes offered more flexibility within the account. A person can now save more with the RESP.
- The RESP account can be held for 36 years.
- The maximum annual amount of basic CESG was increased to $500 from $400.
- Please note that there are different investment vehicles for investors. The issue is to have the correct savings strategy.
At times it is better to consolidate your savings and at times it is better to put your savings in different baskets. For example, you can start to save in a TFSA as soon as you turn 18 and must have a propensity to save decent amounts. At this level you are not in a higher tax bracket to use RRSPs. As soon as your income increases you must consider investing in a RRSP.
Remember that if you are already saving in the Registered Education Savings Plan (RESP) it remains the best place to save for a child’s education because any contribution attracts the 20% Canada Education Savings Grants (CESG). With the introduction of the TFSA, it is best to contribute enough to the RESP to get the maximum allowed CESG of $7,200 per child and save more in a TFSA.
It is good to save for your children’s future. Every parent wants to give his child the best upbringing and schooling. He knows that good education can shape the future of his child. He also knows that shelling out a large sum of money in a single go is difficult. It is best to set your financial goals keeping in mind the different TSFA options.
Insuring a child’s life can be a delicate subject but can make financial sense. Life insurance is used to protect an individual’s family from an untimely death. If a primary-income earner dies, where is the money going to come from to replace the lost income? Most young couples will not have accumulated enough capital to sustain a loss of income. Without life insurance, the consequences can be dire – the loss of the family house and the family’s standard of living being drastically altered.
When analyzing your family’s life insurance needs, the first order of business is to insure the primary-income earners. In most instances, children are not income earners. While a child’s death would have a huge emotional impact, it would not have a dramatic financial impact. That said, assuming that all of your financial bases are covered, insuring a child can make sense and can offer many long-term benefits.
Insuring a child at a young age guarantees that he has insurance now and has the ability to get insurance in the future. This will protect the child’s ability to obtain insurance against future health problems. It will also protect the child against risky occupations such as becoming a firefighter or pilot. Most life insurance policies give you the option of adding a guaranteed insurability rider which allows the child to upgrade his insurance in the future, without a medical.
Permanent policies allow your child to lock in at favourable rates and can be paid up in a limited number of years. The policy can generate cash value which is available in the case of an emergency or to help supplement the child’s retirement income. Permanent policies can also give the child’s future family added financial flexibility – the cash value can be used towards a down payment on a new home or as collateral for a loan to start up a new business venture.
For those cases, where one or both parents have hereditary health issues, insuring a child may have an added importance. Insuring their newest addition at a very young age creates a safety-net against the child developing future health issues. A child who eventually has a family of his own may have developed health issues in the interim and may not be able to obtain new insurance; even if it possible to obtain insurance, a new policy may have a larger premium due to health issues.
So is it simple or silly in your own individual situation? It depends on your personal perspective.
Contributions to both the TFSA and RESP are made with after-tax dollars and both offer the benefit of tax-deferred growth. RESPs have the advantage of attracting the Canadian Education Savings Grant (CESG) of at least 20% but the grant and all the growth within the RESP is taxed upon withdrawal, albeit at the lower rates that beneficiaries tend to pay when attending university. But RESPs have strict restrictions and face heavy penalties if the beneficiary does not attend school. If you discount the initial matching grant, the TFSA is superior to the RESP due to its flexibility.
So, the question boils down to whether the CESG makes up for the main drawback of a RESP, namely the penalties involved if a child does not attend college or university. You’ll have to determine for yourself the chances that your child will get post-secondary education but consider this statistic: among young Canadians aged 18 to 21, about 60% attended a university or college and almost two-thirds went to some kind of post-secondary institution.
If there is a very high chance that at least one child will attend University, the RESP wins out over the TFSA due to the CESG depending on the time horizon and the tax rate on withdrawals. I ran the calculations using the following assumptions: $36K is contributed to a RESP over 14.4 years to get the maximum grant of $7,200. The same $36K is contributed to a TFSA over the same time frame and both accounts earn a 6% rate of return. The CESG and the growth within the RESP is taxed at the lowest level of 15%, a rate that is likely overstated because students tend to receive tax deductions for tuition, education and text books. After 18 years, the RESP has a roughly 10% advantage over the TFSA. If the tax on RESP withdrawals is lower at 10%, the RESP has a 13% advantage after the 18th year.
The calculations confirm my suspicion that it is more profitable to save for your child’s education in a RESP by contributing just enough to get the maximum CESG. But it now makes no sense to contribute the maximum 50K allowed to a RESP over time. It is better to channel any contribution that doesn’t receive a matching grant into a TFSA instead.
Each individual’s siutation is different. It depends on your personal perspective.
As families struggle with what to say to the kids, I think it is important to instill financial responsibility and good money sense. It may be one of the positive aspects of the current economic situation. It provides grounding and a realization that we cannot buy everything we want. Here are a few tips on how to go about doing it:
Talk about the Family Budget
Keep talk of financial issues out in the open, but don’t make it anxiety driven. Offer reassurance, such as “This is how it is now, but we expect it to get better. We are a family and will be fine, but we all need to work on this together.”
Discussions of money can begin with children as young as preschoolers with an explanation of why they cannot have certain things. Point out the savings efforts you too, are making, perhaps with a bag lunch instead of take out, or cutting coupons, or skipping Tim Horton’s and making your own coffee. Let children know that while a big vacation may not be in the offing this summer, that your family will still enjoy trips to the beach or local parks or time spent with grandparents and friends.
If your family tradition has been to go overboard on birthday gifts, this might be the year to make a change. Let your kids know that this year you'll surprise them with a smaller gift, and they'll be able to plan a special day with the entire family. Whether it's a picnic at the zoo, a hot chocolate and sledding fest, or a family feast with their favorite foods, it can be the start of a shift in family priorities.
Keep Budget Information Age Appropriate
Give kids info they can handle. If the kids hear you open a bank statement and groan, they may think you have no money. Talk to them about how the economy is affecting everyone's savings and about how budgeting can help. Explain that your family also needs to watch what they spend. You might say "I know how sad you are that we can’t go out for ice cream. But how about we buy the makings for sundaes at home?" Without these conversations kids stay naïve, and with them, they develop a sense of the value of money.
Give Kids an Allowance
An allowance teaches kids how to use money, as well as how to be part of the family. Kindergarten age is not too soon to start. Chores and an allowance are all part of being a responsible family member. It’s okay to say that as well as to point out the age-appropriate activities your child can do to participate in the family, like putting napkins at the table, taking dishes to the sink, and cleaning up toys and dirty laundry.
Next, teach your kids some strategy for using the allowance. For example, you could start with a three dollar allowance with one dollar marked to spend, one to save and the third set aside to help others. You’re setting limits and teaching them how to budget and what charity is as well.
Discuss money, the economy and budget issues openly and in age-appropriate terms with your children. Focus on the positive measures you and your family are taking and provide fun, alternative activities that fit your family's economic reality. Give kids an allowance and let them use it.
By following these suggestions, you will raise fiscally responsible children.
Bentley Financial, directed by Steve Bentley, is a financial services firm that was launched in 2003. As a progressive financial services firm, Bentley Financial has developed an extensive portfolio of investment and insurance expertise. We provide our individual and business clients access to a professional advisor team that incorporates a wide range of experience and knowledge in tailoring solutions unique to each client and delivered in their own personal plan. Not every plan is the same. Our team’s unique skills and capabilities allow each plan to be carefully tailored to ensure you realize your dreams. Our mandate is to secure your future goals and ambitions. These change over time and your plan needs to be dynamic and this is why we will be with you every step of the way.
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