Tag: RESP

Transitioning RESP to TFSA

The Registered Education Savings Plan (RESP) has been with us for decades now. Alongside, we have witnessed the evolution of the Canada Education Savings Grant (CESG) and other targeted financial support programs. Combined, these are powerful education savings vehicles for many Canadian families.

But can the RESP be even more than a tool for financing education? Can it, in fact, double as a tool for educating on finance itself and be an avenue for establishing lifelong savings habits for both parents and children?

Here are some considerations as to how coordination of the RESP and tax-free savings account (TFSA) might indeed pave the way to that future.

Age horizon for the CESG

The basic CESG entitles an RESP subscriber to 20% in matching grants on contributions. That equates to $500 of grant money that can be earned for a given year of the RESP beneficiary’s life, though as much as $1,000 may actually be paid during a plan year if there is unused room from prior years.  

While an RESP can exist for as long as 35 years, the latest date at which CESG can be earned and paid is the year in which the RESP beneficiary turns age 17. Thus, for many families the practical timeframe is much shorter, particularly if the student is in the common education stream completing secondary school in his or her late teens.  

Whether it makes sense to continue contributing to an RESP beyond this CESG eligibility timeframe will depend on the tax characteristics of both subscriber and beneficiary (most often parent and child, respectively). For some thoughts along similar lines, see my Tax & Estate Matters article from September 2010, “They grow up fast: Coordinating RESPs and ITFs.”

Age onset for the TFSA

Coincidentally, just when the CESG ceases to be available, the TFSA opportunity begins.   

Annual TFSA contribution room (currently $5,000) begins to accumulate the year a Canadian resident turns age 18. If the age of majority in the province is 19 then there would be a year’s delay until a TFSA could be opened. (See grid below.) Fortunately, the contribution room at age 19 would include the carryforward from the prior year, totaling to $10,000 currently.

Continuity of the savings habit

After years of saving, no doubt many parents eye the end of RESP contributions as a welcome release of funds to the household budget. It’s okay to splurge a bit, but they should also keep the big picture in view.

The upward trend of tuition and surrounding education costs does not appear to be abating. Case in point, my brother tells me his son’s first year away at university will cost $25,000. At that rate, even parents who had conscientiously saved may find their RESP resources depleted well before junior dons the cap and gown.

Accordingly, it may be prudent to continue earmarking funds toward education savings. Failing that, parents may have a basement boarder much sooner than anticipated.  

And while it may feel like a leap of faith to give money directly to a child for a TFSA, if carefully structured with incentives, parents can still hold some strings while teaching their young adults important life lessons in tax-efficient saving.

Age of majority

Age 18 – AB MB ON PE QC SK

Age 19 – BC NB NL NS NT NU YK

Source: Citizenship and Immigration Canada

Steady/Study as she goes – Supporting education savings

In August the federal government released the Canada Education Savings Program (CESP) 2009 Review.  

This is the umbrella under which is housed the familiar Canada Education Savings Grant (CESG), and the apparently not-so-familiar Canada Learning Bond (CLB).  (More on the CLB below.)

Overall, past performance metrics for the CESP seem quite positive, and the trajectory for the future appears similarly on neutral to favourable ground.

RESP – Contributions and asset growth

While annual RESP contributions increased in 2009 to just over $3.1B, that is less than a 1% increase over 2008.  At the same time, the number of RESP beneficiaries increased at a slower rate in 2009 (about 6.8%), than the average for the preceding 3 years (9.2%).  Not surprisingly then, annual contributions per beneficiary dropped (by 1.5%) last year for the first time since 2001, falling to an average of $1,423.  

When the CESP was introduced in 1998, Canadians held $4B in RESP assets.  By the end of 2009, those assets had grown to $25.9B, and apart from the 2008 downturn when there was a 3% decline, RESP assets have increased every year since CESP inception.  

Of course a 3% drop is a mere blip in comparison to the way general investment and retirement portfolios may have fared in 2008.  Consider though that the asset tally includes existing assets from the prior year plus contributions and CESP supplements.  Respectively, those additions in 2008 were $3.1B and $599M.  If one carves out these additions, existing assets declined by about 19% that year.

And though one might expect fairly conservative approaches to RESP investment, I am reminded of a friend who stuck it out with the markets through the downturn.  With one child having started university in 2009, and another commencing this September, he is now lamenting not having glided to conservatism in these lead-up years.  He may work a bit longer to pay the education tab now, but presumably their success will be the payback.

CESG – Dollars and participation rates up

Total CESG payments have increased every year since CESP inception, up 2% from 2008 to 2009 at $612M.  Over its history, the CESG has contributed almost $5.1B toward education savings.

The average age of new beneficiaries has decreased every year since CESP inception in 1998 when the average child was almost 8 years old.  For 2009, average age is 3.6 years, which the Review suggests is evidence that the program has encouraged families to begin saving early for post-secondary education. 

It is estimated that over 40% of children up to age 17 participated in the CESG in 2009, with peak participation occurring in the 5-9 age range at over 45%.  There is no explanation or suggestion for this phenomenon, though greater promotion in recent years may explain higher participation of younger children.  As to the very young, as a parent who is just getting the last of 3 out of diapers, I think I know where some of the money (and distraction) goes early on. 

CLB – Money left on the table

While much of the report is rosy, one troubling aspect is the low participation rate for the Canada Learning Bond.  Acknowledging that participation rates have increased by about 5% annually from 2005 inception up to 2009, a rate of 19.3% is unfortunately low.

To summarize the CLB, it is aimed at children from low-income families, using entitlement to the National Child Benefit Supplement (NCBS) as the qualification criterion.  It pays an initial $500 directly to a child’s RESP, and another $100 for each year of continuing eligibility to age 15 – and does not require matching parent contributions. 

So, if qualification is independently determined, and the parent need not be out-of-pocket … why don’t we see 100% participation?  I can’t answer that, but I do have a suggestion.

This is not a mere statistical estimate of qualification: The NCBS, as part of the Canada Child Tax Benefit (CCTB) program, is monitored using parents and children’s social insurance numbers.  This is tracked and shared with those parents on CRA’s “My Account” secure web-server.

So here is the suggestion: 

Maybe the government could credit the CLB amounts to the appropriate My Account location for children of NCBS entitled families.  Credits would earn no income, but could be wired to a financial institution once an RESP is actually opened.  If no RESP is ever opened, then the credit could be triggered in future if and when the child claims a tuition credit or provides similar evidence of qualifying post-secondary education.  

It may not be quite that simple, but I don’t think it’s much more complicated.

Tax talk on the dock – 5 planning points for an investing skeptic

I had the opportunity to catch up with an old friend by a dock earlier in the summer.  

He is a true entrepreneur who took a calculated risk, established a successful business, sold to a multinational, had a brief retirement (at age 40) and a few years later is looking for the next challenge.  

With those buyout funds in hand, he observed the recent economic turmoil with much skepticism about market investing.  Actually he was a skeptic well back in time, and those funds never left the safety of his bank account.  Even so, he knows he can’t remain on the sidelines forever.  

So as summer comes to a close, here is what we threw about, apart from the horseshoes and mosquito swatter. 

Run a business, if you are so inclined 

My friend firmly believes that true wealth is built through active business management.  And given his track record, I can’t disagree that a well-run enterprise can net impressive results – emphasizing the requirement to be well-run.

In actuality, he is something of a zealot when he extols the virtues of running a business, and more specifically the benefits of running a business through a small business corporation.  He is living proof of the value of the small business rate, spousal income splitting and the lifetime capital gains exemption.  Heck, he almost bubbles over in recalling the joys of a well orchestrated salary-dividend mix.

However, running a business is more than merely a financial decision, whether tax-driven or otherwise.  In many ways, it’s a lifestyle choice, and has to be undertaken with that aspect clearly in focus.

Kill the mortgage

There is perhaps no more clearly predictable rate of return on applied money than to eliminate a big debt like a mortgage.  Somewhat ironically, that kind of arithmetic certainty dovetails well with the more nebulously measured emotional comfort of being mortgage-free.  Hey, it’s your home.

In his case, he had already achieved this prior to the business buyout.   

That’s not to say that he was pursuing mortgage retirement to the exclusion of retirement savings.  Rather, he placed more proportional emphasis on the mortgage than any raw calculus might explain. 

Now being free of that debt burden, he is committed to becoming more knowledgeable and effective in fashioning his retirement income plan. 

Getting 20% upfront on your RESPs

As people within the financial service sector, sometimes we forget that those outside the field have things on their mind other than the nuances we see much more regularly.

For instance, my friend was not even aware of the 20% Canada Education Savings Grant he was receiving on his RESP contributions.  Thus, he was only contributing paltry amounts well below the $2,500 limit upon which the current year’s entitlement would be maxed out.  

On the positive side, now that it is possible to pick up past years’ unused room, he will be able to get up to $1,000 CESG annually by putting in $5,000 for each of the kids until he catches up.  Yes, he’s the same skeptic about market investments, but that’s a whopping tax/support benefit left on the table if that CESG is not unclaimed.

It remains to be seen whether he is inclined to make any further use of the RESP tax sheltering room beyond the CESG entitlement thresholds.  

We differ on life insurance

While we are roughly on the same page that life insurance is a top priority matter for income replacement purposes, beyond that we diverge a bit.

He waffles on what to do with current life insurance, given the lack of an income replacement need.  In not so many words, he defines that need in terms of whether his family would suffer a drop in lifestyle should he be removed from the equation.  In that context, I agree that he does not need to replace income.

That said, terminal taxes and final debts loom, distant though they may be in the future.  A tax-free death benefit may make sense to service that eventuality.  Past premium payments are water under the bridge, and future premiums continue to be priced based on an earlier age.  

A consideration of the internal rate of return of continuing premium payments may prove fruitful.  That’s the kind of analysis an entrepreneurial business mind can appreciate.

Do the Wills

Actually they have done their Wills, but that was well before the business came to together and was later harvested.  

The tax benefits of testamentary trusts may have been a passing topic in those earlier estate planning discussions, but now the benefits are very real – for the couple, the kids, and who knows who or what may come up in summers ahead.