An Alternative to RESPs

Statistics Canada estimates that the total cost of a four-year university education is more than $80,000,  including tuition, housing, food, books and additional fees.

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The Real Costs of College

When you think about how much it’s going to cost to send a child to college, you often concentrate only on the direct costs such as tuition and books. But there are indirect costs that also need to be considered.

Here’s a list of both types of expenses to evaluate when you are planning the costs of giving your child a higher education:

Direct Costs

  • Tuition: Some schools charge a flat fee, but others charge by the credit hours taken. Assume a minimum of 15 hours per term.
  • Room: This depends on whether the student lives in a dorm, an apartment or group house, or with a relative. Colleges usually provide an average figure for dorms, so use that because you won’t know the actual amount until your child has been assigned a room.
  • Board: If your student eats on campus, the school may require all meals to be taken in a dining hall or other campus facility. Some schools offer flexible meal plans, which are handy if your child doesn’t need three full meals a day seven days a week. The school’s estimates won’t include snacks or socializing. If the student lives off campus, calculate based on the usual amount consumed in a week at home.
  • Fees: Some fees are required and others depend on the course of study. For example, if your child takes science courses, you may be charged a lab breakage fee for each course. Some schools charge a student services fee based on participation in certain activities. And there may be fees for uniforms and equipment if the student plays a sport.
  • Books and Supplies: This depends on the student’s field of study. Science books can cost as much as $75 or more, and a literature course could require as many as 10 books. There may also be charges for workbooks, photocopied articles and study guides.

Indirect Costs

  • Transportation and Travel: Include commuting from the local residence to classes unless the student lives on campus, and travel expenses to and from home during school breaks. If the student has a car, include parking fees, insurance payments, and gas, oil, and maintenance.
  • Personal Expenses: Don’t forget the costs of laundry, entertainment, toothpaste, razor blades, haircuts and the like. They add up.

So it is no surprise that parents are looking for efficient ways to finance their children’s educations. Often the parent, or a grandparent, will gravitate to a Registered Education Savings Plan (RESP), the country’s top choice for financing higher education.

The popularity of RESPs stems from tax-deferred compounded growth, lower taxes on withdrawals because they are taxed to the child, and federal grants that help build the savings even faster.

But if the beneficiary decides not to get a higher education you may not be happy with the rules for accessing the money you’ve been putting aside.

For one thing, you must return to the government the grant portion of the RESP.

Then, in order to access the remaining money, three conditions must be met:

1. The account must have been open for at least 10 years,

2. The beneficiary must be at least 21 years old and be ineligible to receive education assistance payments from the plan, and

3.You must reside in Canada.

And then you have only two choices:

1. Transfer the money to a Registered Retirement Savings Plan (RRSP) held by you or your spouse or partner, provided there is contribution room, or

2. Withdraw it as cash and pay both your marginal tax rate as well as a 20 per cent penalty on money that you earned in the plan.

The alternative to these savings plans is an informal trust account.

The key difference between saving in-trust for your child and setting up an RESP is that the child has guaranteed access to the cash when he or she reaches the age of majority in your province. The money does not have to be used for schooling but could instead go toward travel, buying a car or home, or setting up a business.

But the money does belong to the child. You cannot access it unless it is for the benefit of the child. The money in an RESP belongs to you.

These informal trusts differ from formal trusts. The latter require a legal trust agreement, generally cost more to set up and administer, and are usually used for very large sums of money.

Informal trusts are simpler to set up and generally take the form of an in-trust account with a bank, trust company, credit union, investment company or mutual fund company.

Unlike an RESP, there is no limit on how much money may be held in the trust and no limits on when and how much you can contribute. That means you can put aside more than the lifetime maximum of $50,000 per beneficiary allowed by the registered plans. However, the trusts do not qualify for the federal education grants.

While setting up and contributing to an in-trust account is relatively simple, the tax structure is complex.

Income attribution rules apply to in-trust accounts. That means income such as dividends and interest are taxed in the hands of the higher tax bracket parent or adult who set up the trust.  If the trust is used exclusively to save Canada Child Benefits payments, however, interest and dividends are taxed to the lower tax bracket child.

Generally, then, in-trust accounts focus on growth stocks or mutual funds that invest in stocks, where growth is primarily from capital gains. There is no attribution of capital gains, and thus they are taxed to the child.

When money is withdrawn, the beneficiary will not owe taxes on the amounts you contributed. That’s because you put in after-tax dollars, so you have already paid income tax on the principal invested.

Using informal trusts is a complicated and at times controversial strategy that involves complex tax issues often reviewed closely by Canada Revenue Agency (CRA). Be certain to consult your professional advisor for help minimizing taxes and getting the most out of an in-trust education account.

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