Education funding strategies: A family affair

When Chris and Jamie welcomed Kelly, their first child, they were overcome with well-wishes. Friends and family showered them with gifts for their newest family member. Everyone knew education was highly-valued to the family, so it wasn't surprising when multiple people wanted to help set Kelly up for a successful future by contributing toward her education. 

Chris and Jamie were given cash gifts to be used toward Kelly's education, and both sets of grandparents talked about setting up Registered Education Savings Plans (RESPs). Keith, Chris' brother, even talked about establishing an informal trust account that he would add to on birthdays and holidays. With money and well-wishes in hand, what should Chris and Jamie consider when planning how to maximize Kelly's education savings? 

Chris and Jamie 

Chris and Jamie are fortunate to have the opportunity to contribute early. By doing so, they could benefit from many years of tax-free compounding of contributions, Canadian Education Savings Grants (CESGs) and investment returns. To maximize the CESGs every year, they should plan to contribute $2,500 annually. If they have extra money in those early days, perhaps monetary gifts from family members, they could contribute more than $2,500 and benefit from years of tax-free compounding. But they should be careful not to front-load the contributions too heavily. If they contribute too much in the first years, it could mean they miss out on CESGs in the later years due to lack of available contribution room. Their financial advisor could help them determine the ideal amount to contribute and the best timing for those contributions. 

Kelly's grandparents 

Kelly's grandparents are all very keen to be involved and would like to establish individual RESPs, but in most circumstances, this would not be well-advised. While a child can be a beneficiary of multiple RESPs, the contribution limit remains the same. If multiple plans were not very carefully coordinated and monitored, there could easily be an inadvertent over-contribution, which could result in a penalty. Even where over-contribution is avoided, having many plans could have an impact on the appropriateness of the asset allocation within the plans. 

There are additional potential issues for grandparent subscribers as well. If the child does not pursue post-secondary education, the income will be paid back to the grandparent. If he or she has contribution room, they can transfer up to $50,000 to their own Registered Retirement Savings Plan (RRSP) without penalty. But if they don't have room or are beyond the RRSP contribution age limit, they will not only be fully taxed on the amount, but will also face a steep penalty. And if the grandparent predeceases and names the child's parent as the successor subscriber, the parent will be similarly prohibited from transferring the funds to his or her own RRSP and will be fully taxed. 

The better option may be for the grandparents to gift the money to the parents who can then use the gift to fund an RESP for the child. This would mean a loss of control of the funds and the parents would have the ability to withdraw contributions without the grandparents' consent, so the appropriateness of the solution would need to be assessed in each family's unique circumstances.

Kelly's uncle Keith 

What about Keith's plan of opening an in-trust account that he could add to over the years? Often referred to as "informal trusts" these are accounts that should be approached with great caution. There should be a clear understanding of whether a trust is in fact being established and what that means for both the contributor ("settlor" in legal-speak) and the beneficiary. 

Keith might be thinking he'll just open an account that is earmarked for Kelly's education. But very often the well-intentioned contributor does not understand the legal and tax implications of these types of accounts. There are complex tax attribution rules that must be adhered to, and separate tax returns may need to be filed. Additionally, confusion may arise in the event the settlor dies unexpectedly or is subject to creditor claims, and ultimately, in the absence of formal documentation saying otherwise, the beneficiary of the account would generally be entitled to those funds upon reaching age of majority. This means they could use the money however they chose — regardless of the settlor's intention for the funds. Again, a better plan may be for Keith to gift the funds to Chris and Jamie to use toward an RESP for Kelly. 

Additional strategies to consider 

There are additional strategies to consider, such as utilizing the parents' Tax-Free Savings Accounts (TFSAs) to build additional tax-free education savings outside of the RESP (but without the benefits of CESGs). There are also more advanced strategies for higher-net-worth families, such as prescribed rate loans. 

Key steps

Whatever the approach Chris and Jamie take, there are several key considerations they should keep in mind: 

1. Look at the big picture.They should work with their Edward Jones advisor, and their tax and legal professionals, to develop personalized strategies to help them achieve their financial goals (rather than thinking of education funding in isolation). 
2. Apply for a Social Insurance Number (SIN) for Kelly. To open an RESP, the beneficiary must have a Social Insurance Number, so Chris and Kelly should apply for one as soon as possible. 
3. Consider the tax consequences. If either Chris or Kelly is a U.S. person, there may be additional tax complications that should be reviewed with their tax, legal, and financial advisors. 
4. Review their estate plan. As with all financial planning, Chris and Jamie should ensure their estate planning documentation contemplates their education savings strategy. In the case of the RESP, that likely means ensuring that an appropriate successor subscriber has been named.

Chris and Jamie can start today by talking to their Edward Jones advisor, who, together with their tax and legal professionals, can help them create a personalized strategy based on what's most important to them.