What are some of the options available to help parents ease the cost of post-secondary study?

If you have school-age children, it’s hard not to think of the road ahead as you watched (or helped) them head off to school last Tuesday. With today’s knowledge-based economy, many parents hope that their children will decide to pursue some form of post-secondary education – a hope tempered by the fear of financing a trip to the halls of higher learning. What are some of the options available to help parents ease the cost of post-secondary study?

1. One approach involves a parent or parents saving and investing in the hope that sufficient funds will be set aside when the post-secondary years arrive. This approach may work for hardcore traditionalists but it suffers from two critical shortcomings: (1) the investment income earned is taxed at the saving parent’s marginal tax rate thereby diminishing the size of the fund available at the end of the day, and (2) it fails to take advantage of any government incentives available along the way.

2. If you are in receipt of a Child Tax Benefit, each payment received could be set aside in a separate bank or investment account in the name of the child. Income earned from amounts invested in this manner is taxable to the child and not the parent. In many cases this means that no income tax will be paid on the investment income earned because each Canadian taxpayer (including minors) is entitled to the Basic Personal Exemption ($7,412 in 2001) every year – this represents the amount of income that can be earned each year before income tax will have to be paid. Even if the child’s investment income in the year exceeds their Basic Personal Exemption, depending on the source of income (interest, dividends or capital gains) a tax rate of no more than 23 per cent would apply to the excess income as long as the total did not exceed the top of the lowest income tax bracket ($30,484 for 2001).

So this approach deals with the tax issue but it still fails to take advantage of government incentive programs. It also suffers from a lack of control. When the child recipient of the Child Tax Benefit reaches the age of 18 he or she is free to do with the money as they please – it is, after all, their money. Your dreams of financing an education may end up as a down-payment on a “cool” car and there won’t be a whole lot you can do about it.

3. If your child works part-time while going to high-school, you could have them save and invest every penny they make while paying for all of their personal needs out of your own pocket. The basic idea here is to build an investment fund in the name of your child rather than accumulating funds in your own name. For reasons stated in (2) above, both the child’s salary and investment income will be free of tax provided they do not exceed $7,412 in the year. If the child’s income from all sources exceeds this amount only the lowest personal income tax rate will apply to the excess income. This tax rate is likely to be substantially lower than your personal tax rate – less money paid to the government means more money available to pay for tuition fees and the like.

Once again this approach does a good job eliminating or reducing income tax on the funds set aside for education but it lacks the element of control by the parent and fails to take advantage of government incentives.

4. An outright gift of money to your child (even a minor child) can also reduce or eliminate income tax provided the funds received are invested to produce only capital gains and not interest or dividend income. Tax law contains a set of rules, known as the attribution rules, that attribute income back to the parent who gifted the property to the minor child. In other words, the income earned on the gifted funds will be taxable to the parent who provided the gift and not the child who received the gift. These rules only apply to interest and dividend income and not capital gains. So, for example, if a cash gift is made to a minor child who then acquires a mutual fund that produces only capital gains and not interest or dividends, there will be no attribution of income back to the gifting parent.

Like the two previous options, this approach is tax effective but suffers from a lack of control by the parent and fails to tap into government incentive programs. This approach does, however, entail greater risk than the above options since you are forced to seek out capital gain producing investments – anyone who has invested in the stock market during the past year or so will know that this is not an easy thing to do.

5. This brings me to the last option on my list – the Registered Education Savings Plan (RESP). Up until several years ago, the rules surrounding RESPs tended to be somewhat restrictive causing many potential investors to shun them. In 1998, changes were made to the RESP rules making them significantly more attractive as education investment vehicles. Next week, I’ll review the RESP rules and why this investment program is now worth a second look.

Jim Maroney is a chartered accountant with Andrews Brown Maroney in Maple Ridge.