Beyond RESPs: alternative education saving strategies

Established four years ago, TFSAs now have up to $20,000 in available contribution room for Canadian adults. For clients who have not used their entire contribution amount, it provides a vehicle to save some extra dollars tax-free.

“If clients haven’t used up their TFSA limits, then this is always a great option for additional education savings,” says Sara Kinnear, director of tax and estate planning at Investors Group Inc. in Winnipeg. “It doesn’t make sense to have non-registered money on the table when you could be putting it into a TFSA. They are just so advantageous.”

Once a child turns 18, a parent could contribute to a TFSA account in the child’s name. However, clients should be made aware that the child will have control over the funds in his/her own account, and may not use them for education purposes.

Trust accounts

Trust accounts also provide clients with a tax-efficient opportunity to save for a child’s education. Clients can contribute money into a trust account in the child’s name, with the capital gains portion taxed in the hands of the child.

Clients can choose between a formal or informal trust account. Informal accounts, or in-trust accounts, do not have legal documents attached to them and therefore may not be recognized in a court of law without supporting documentation. In addition, once a child reaches the age of majority, they will be able to do what they want with the funds.

Setting up a formal trust account may be a better option for parents who don’t want to see their child gain control of the funds at an early age, says Kinnear.

“I’m not a big fan of informal trusts because I like clarity and being able to predict what is going to happen and you don’t necessarily get that with an informal trust,” says Kinnear.

With a formal trust, parents can set their own terms and conditions, such as how funds will be used and at what age a child has access to them. Regardless of how simple or complex the trust rules are, all formal trust accounts require a legal document known as a deed of trust.

Company dividends

Clients who have family companies may want to look into funding their child’s education through company dividends. In this strategy, clients provide their children with non-voting shares of the company. Dividends would not be paid until the beginning of the calendar year in which the child turns 18. Once the child turns 18, the company would then pay out dividends that would be used towards education costs. The dividends would be taxed in the hands of the child, who would presumably be in a lower tax bracket than the parents.

Universal life insurance

Another education savings strategy that clients can use in addition to their RESP savings involves using excess money from a permanent life insurance policy that has a cash value option. Universal life is used most often as it has flexibility when it comes to cash deposits. A parent or grandparent can apply for a life insurance policy while a child is still young, naming the child as the insured and the parent as the owner.

The parent will then put in additional dollars above his or her monthly premium amount. Those funds will grow tax-free, and once the insured child reaches the age of majority (or some later date that the parent determines), the parent can transfer ownership on a tax-free basis to the child.

“That is what makes this strategy sing,” says Bob Allebone, manager insurance and estate planning at Investors Group in Winnipeg.

The Income Tax Act provides for the ability to transfer ownership of a permanent life policy to a child on a tax-deferred basis as long he or she is the only child insured and the policy is owned by a parent.

This option is suitable for all investors, keeping in mind that contributions to the policy should be more than the set minimum premium in order to accumulate cash savings within the policy, adds Allebone.

The larger the policy, the more cash a client can accumulate on a tax-deferred basis, but there is a set maximum depending on the policy amount as well as the age and gender of the child.

“The good news about this method is that the money does not have to be used for education should the child decide not to pursue higher education,” says Stephen Smith, president of Yorkminister Brokerage Insurance Ltd. of Pt. Hope, Ont. “Should the parent be concerned about giving a significant asset to a young person, he/she doesn’t have to be. The parent can keep the funds and consider other options at a later date.”

This is the third article in a three-part series on education planning.