Contact

Education Funding

For those with lots of money to contribute, a family trust might be in order with the children named as beneficiaries. The trust would operate on the basis of funds loaned or gifted to it and would invest the proceeds in whatever your investment advisor recommends. It might purchase a life insurance policy on the donor of the funds, especially if the donations are over a number of years, as a self-completion measure, in case you don’t live long enough to see the plan completed. Accounting, legal, and financial counsel should be involved if you are going down this road but it is a very useful mechanism for families who have a lot of money.

Another, simpler, choice would be the direct purchase of a universal life policy on the life of your child or as a joint life policy on the parents. It would need to be funded with far more than just the minimum premium to keep the policy in force since the objective is to build large cash values within the policy. Successful investment of the funds within the policy would do this, sheltered from taxation whilst they remain in the policy. If the child is the owner of the policy, the child could withdraw these funds when needed for education expenses and be taxable at his or her own rates, whilst having the benefit of tuition expenses as an offset. Conceivably this mechanism might work for private school fees or even expensive summer camp expenses. There is no restriction as to purpose other than your own intentions. The life insurance cost component of the policy would be more expensive if the lives insured are the parents but this could build in a self-completion mechanism should the parents fail to live long enough to see the education completed. However it the child’s life is insured it could be the basis of a long-term life insurance program for them.

The use of a mutual fund account for funds you might set aside for your child is another thought. Since you already have a Social Insurance Number for the child, you can buy the funds in the child’s name and let them accumulate for the purpose. This could be less satisfactory since attribution rules could pertain but, depending upon the nature of the fund, on-going taxation might be minor.

With all these suggestions it would be important to seek legal, accounting, and financial counsel to be sure the plan works in your particular circumstances since moving funds between generations can bring taxation issues to the fore. We are not herein proposing solutions to the education funding dilemma. Rather we are suggesting there are several approaches you could consider. We invite your call to discuss.

© Provided as a service to the clients and associates of
STEPHEN B H SMITH, CEB, CFP, PRP
YORKMINSTER INSURANCE BROKERS LIMITED
105 Dorset Street West, Port Hope, Ontario, L1A 1G4
Tel: 905-885-4977 Tollfree: 1-800-668-1751
Fax: 905-885-2556 Mobile: 905-373-5670
sbhs@yorkminster.ca| www.yorkminster.ca

Education savings plans abound. You can buy them almost anywhere they sell RRSP’s. They are not all alike. Usually the “packaged” plans are not as good as one you design for yourself.

Traditionally the packaged savings plans involved your putting the money into a trust managed by a scholarship trust group. At your child’s age 18 you get your money back without interest. One-third of the interest accumulation is paid to the child provided the child makes it successfully through first year at college; another third after getting through second year; and the rest on successfully getting into fourth year. If they don’t make any of those steps, they are cut off from further benefits. Usually the funds are invested in guaranteed investment certificates so the risk of losing anything is low, as is the investment return.

So there is virtually no risk that you would not get your money back. But there is an opportunity risk that you would not get any return on your money. And certainly you would not know how much was going to be paid to your child since you would not know how many of each year’s cohort would make it to the next level of higher education. A good scheme in principle, but flawed.

Though it may be flawed, we do not recommend anyone drop out of one of these plans once going for more than a year or two since, if your child does manage to collect all the way through, the return on your money can be quite exciting. It’s the risk element that deters us from recommending the plans in the first place. The risk is that your child may not go to college at all, may not go to a college on their approved list, may take time off and go to Europe for a few years before going to college, or who knows. Any of the above could cause the plan to not pay the benefits, only the original principal amount contributed in the first place.

Other plans involve holding funds in trust for your children. Or life insurance policies to produce a cash value at the appointed time, age 18 of the child. These have merits if they are done properly. But not if they are not.

The federal government has come up with an education subsidy for your children. They will contribute 20% of your contributions, up to $400 annually, to a Registered Education Savings Plan you establish for your children. This is a tax-free grant that only needs to be paid back if it isn’t used for the purpose intended, and even then, without interest. So you do need to take part in it.

What is a Registered Education Savings Plan (RESP)? This is a plan that allows tax-free accumulation of funds for education of your children. It does not permit tax relief on the contributions (like an RRSP) but the tax-free accumulation is worth a lot. As a trust, it allows the accumulated funds to be paid to the beneficiary (your child) at the point when education costs need to be paid (college, not private school). This means the child is taxable on the growth part of the funds in his or her tax bracket, but they have the advantage of being able to deduct tuition and other student-related items, so taxation should be less than if you received it in your hands.

This very useful income-splitting vehicle has been around for some years, but the federal government’s subsidy is what makes it sizzle. We recommend that everyone who has a child or grandchild or God-child who needs to be educated take advantage of it. At least up to the point as would draw the maximum federal government subsidy (ie contribution), which is at the $2,000 annual contribution level. In order to take advantage of it, the child needs to have a Social Insurance Number. So parents should get one for their child as soon as possible after birth.

The difference between what will attract the maximum federal contribution and the maximum allowable annual contribution to an RESP is a different matter. We do not normally recommend putting more into an RESP than would attract the maximum federal contribution. This is because of the strings attached to an RESP, namely that the funds are to be used for the child’s education.

The individual RESP is better than the old-fashioned “scholarship plans” described above, in that the funds are used solely for your child. But supposing the child doesn’t want to be educated? In effect, the funds are tied up in an education trust until somebody in your family becomes a full-time student. If nobody does, there are some adverse income tax consequences in getting the funds back out. However there is the probability you can find somebody in your network to use the funds.

There are other options for education funding for the amounts over and above what you need to contribute to the RESP in order to get the maximum federal government grant ($2,000 for $400).