The Cost of Raising a Child
The greatest cost in raising children may potentially be the cost of education. There are several ways to fund a child’s post secondary education. One way might be to anticipate that a child will receive scholarships or use student loans, while other parents may decide to pay as they go.
Whichever method parents choose to assist their children it is important to keep a mental note of the potential costs for budgeting your cash flows. Like all plans, your future costs should also factor in the unexpected. An unanticipated disability, death, divorce or other family emergency may interfere with your children obtaining an education. In many cases purchasing adequate insurance may offset some of the risk if a supporting spouse were to become disabled, suffer a critical illness or pass away.
Today, many young parents are struggling to make ends meet. Paying the household bills, including the mortgage leaves little left over for education planning. Contributing to RRSPs provides a deduction from taxable income whereas RESPs do not provide this immediate tax relief. Last week we discussed the basics of RESPs and the following outlines a few points to consider when looking at an RESP for a child.
Attribution Rules: Normally, when you give your minor child money, interest or dividends earned on this money is taxed as if you had received the income (i.e. income is attributed back to the parent and taxed in their hands). Capital gains income does not attribute back to the parents. The attribution rules do not apply to RESP contributions.
Planning Contributions: It may be very difficult for parents to contribute $2,000 every year. Although the compounding component to investment returns is important, it is only one factor to consider. Contributing a smaller amount, say $1,000 beginning immediately, is one option. Another option may be to wait until your child is older and then contribute a greater amount, up to the yearly maximum of $4,000. Both possibilities enable you to take advantage of the Canada Education Savings Grant (CESG).
Pre-Authorized Contributions: Setting up a monthly pre-authorized contribution (PAC) is often the easiest way for a family to get started with investing. Benefits of a PAC include dollar-cost averaging and the benefits of compounding over the long term. Every month the CESG is paid based on a minimum of 20 per cent of the preceding months contributions. Some financial institutions may not have systems in place to administer frequent contributions to RESPs. The timing of the CESG payment may differ between financial institutions.
CESG: The CESG is at least 20 per cent of contributions to a maximum of $4,000 annually or a lifetime total benefit of $7,200. Utililizing the $7,200 CESG is a prudent move as this investment effectively provides a minimum 20% return upon contribution into the plan. Although individuals may make a lifetime contribution up to $42,000 into an RESP they are effectively only obtaining the grant on the first $36,000. If you multiply $36,000 x 20% you obtain the maximum CESG of $7,200. The CESG makes RESPs for children very attractive. Contributions over $36,000 are less appealing.
Grandparents: Many grandparents are proud to start the next generation off on the right foot. Funding an RESP is a great way to help both their children and grandchildren. Godparents, friends and other family members may also be the subscriber of an RESP for a child.
Individual vs Family: An individual plan is set up for the benefit of one person. A family plan is set up to allow contributions to be made for more than one beneficiary. The one condition is that all the beneficiaries must be related to the contributor(s) by blood, but not nieces or nephews. Contributors decide on how the plan’s assets are invested along with the timing and amount of the education payments. The main benefit of a family plan is that RESP income does not have to be paid out proportionately between beneficiaries. If one child does not pursue post-secondary education, the other beneficiaries may use the income for their education.
Student Tax Initiatives: The 2006 federal budget contained a number of proposed changes to personal income tax, some of which affect students. For 2006 and future years, a non-refundable textbook tax credit will be introduced for post-secondary students. The credit will be calculated with reference to the lowest personal tax rate and will be in addition to the current education tax credit. Textbook tax credits are able to be carried forward and have the same transfer rules as tuition and the education tax credit. For 2006 and subsequent years scholarship, fellowship and bursary income will be fully exempt from tax with respect to post-secondary education and occupational training.
The First Step: In order to get started with an RESP today, a child needs to request a social insurance number. An excellent source for information is www.servicecanada.gc.ca which includes information for parents. The Human Resources and Social Development (HRSD) website at www.sdc.gc.ca also provides detailed information on obtaining a SIN for the first time. The website enables you to download a current SIN application form. To locate an office near where you live to pick up and/or drop off forms call 1-800-OCanada (1-800-622-6232).
Applying in person, rather than mailing the application, may be faster and more convenient. Another benefit of applying in person is that you are not required to part with your identification documents because your identification is verified at that time. If you obtain an application form from another source or financial institution, you should ensure that the form is current. The application process normally takes three to four weeks before you receive the physical card provided that your application meets all criteria. In extenuating circumstances, a SIN may be obtained verbally in a shorter period with the physical card to follow at a later date.
With the combination of tax sheltering and the CESG, an RESP may play an important role in your family’s education savings strategy.