Education funding can be as easy as learning your ABCs. There are three main steps, as outlined below. The first two involve learning the habits that all successful adult investors eventually cultivate. The third is that students with any earned income at all should strive to file tax returns each spring. It pays off in many ways.
I remember taking my two little pre-school boys to the bank each month to put $30 into “in trust” savings accounts. That simple routine instilled the habit of regular saving for a future purpose and maximized the time value of money; the longer the compounding period to age 18, the more the funds grew.
Put your savings in the right places
There was also a tax strategy to our monthly pilgrimage. The boys’ accounts housed the equivalent of today’s Universal Child Care Benefits (then called “Family Allowance”). As long as accumulations were not tainted with birthday money or other adult-source funds, we avoided the “Attribution Rules.” Thus, investment earnings like interest or dividends were not attributed back to their adult transferor. Canada Child Tax Benefits received for a child or earnings from part-time jobs qualify, as do capital gains, even if the source of the principal came from an adult.
Ensuring tax-efficient withdrawals later begins when you diversify the “savings buckets.” Here are three great options:
❑ Registered Education Savings Plans (RESPs) are a lucrative way to save for minors. Earnings are sheltered while money is in the RESP. Ottawa sweetens it with the Canada Education Savings Grant (CESG). This equals 20% of annual contributions for each beneficiary, to a maximum $500. ($1,000 if you have unused grant room from a prior year.) Maximum lifetime CESG is $7,200 and special rules for 16- and 17-year olds may affect eligibility.
There’s no tax deduction for the RESP, so later principal withdrawals aren’t taxable. Only the CESG and accumulated earnings are taxable, but in the student’s hands. Education Assistance Payments (EAPs) are usually tax-free, as most student income is below the Basic Personal Amount ($11,038 in 2013.) If they don’t attend post-secondary school and amounts can’t be transferred to family members, the CESG and earnings must be returned to subscribers as Accumulated Income Payments (AIPs). They must be included in income and a 20% surtax applies, unless contributors have RRSP room into which the amounts can be deposited.
❑ The RRSP opportunity. It’s important that working teenagers file tax returns each year to build RRSP contribution room based on 18% of part-time earnings. If the student saves in an RRSP later, resulting deductions reduce net income, increasing access to tax credits. Also, tax-free RRSP withdrawals up to $20,000 can be made under the Lifelong Learning Plan. Students must repay over a maximum of 10 years or missing annual installments will be added to their income.
❑ The Tax-Free Savings Account is a great choice for resident students saving for post-graduate degrees. You must be 18 to open a TFSA. There’s no tax deduction for deposits but earnings are tax-free, you never lose contribution room, and you can replenish the TFSA to save for a mortgage after graduation.
File a tax return each April
Tax filing for students completes the savings circles, enhancing tax-wise funding withdrawals. Consider these strategies:
❑ Transfer credits. Full or part-time students qualify for tuition, education and textbook credits: valuable if they pay federal or provincial taxes. As few students do, all or some of these credits can be transferred to supporting individuals. If student income just exceeds the Basic Personal Amount, the student’s RRSP deduction can reduce income to enable the transfer. RRSP room is required.
❑ Get more free money. Students can file for “free money” from refundable tax credits like federal GST/HST Rebates or provincial tax credits and graduate tuition fee rebates. Tax filing needn’t cost much; software may be free for students who NetFile.
❑ Make student debt deductible. Student financing may qualify for a tax break. Student loan interest from three sources qualifies for a non-refundable tax credit claimable by a student or related person: the Canada Student Loans Act, the Canada Student Financial Assistance Act, or similar provincial or territorial laws.
If no tax is payable, interest can be carried forward and applied over five years. Interest on personal loans or lines of credit are funding sources that don’t qualify.
When you build your child’s education nest egg carefully and withdraw it tax efficiently you will cement your child’s future and ultimately, your family’s wealth. M
Evelyn Jacks is president of The Knowledge Bureau, an educational institute for financial advisers and clients. For certificate tax, retirement and investment courses see www.knowledgebureau.com or call 1-866-953-4769.