Doctors are even more keenly aware than most Canadians how expensive post-secondary education can be. With tuition rising every year, you may be thinking of chipping in to help the parents or guardians of your grandchild, niece or nephew, godchild or family friend — or any young person in your life — pay for their post-secondary education.
Cash gifts are always an option (there's no gift tax in Canada), but there may be better methods available — even if the young person you want to find a way to help support is about to finish their undergraduate degree and enter medical school or another graduate program.
Here are five ways a non-parent/legal guardian can help fund a child's post-secondary education, as well as various factors to consider when choosing between them.
1. The registered education savings plan (RESP)
Although you can open an RESP to help any child pay for post-secondary education, this type of account is most advantageous if started while the student is under 18.
Your contributions earn interest or investment income tax-free either way, but the Canadian government only kicks in the additional funding that makes RESPs such a great saving vehicle in the years before the child turns 17.
What is an RESP?
It's a registered savings vehicle is designed to fund a named beneficiary's post-secondary education. An RESP can be opened for a beneficiary of any age — from infant to adult — who is a Canadian resident and has a Social Insurance Number (SIN). Once the RESP is open, you can contribute to it for up to 31 years (with a lifetime contribution limit of $50,000 per child) and the account can remain open for up to 35 years.
There are no restrictions on who can open or contribute to an individual RESP — parents or guardians, grandparents, other relatives, friends or anyone else can do so.
You'll need to consult and co-ordinate with the parents or guardians — you need the child's SIN to name them as the plan's beneficiary. Plus, RESP contribution and grant limits are tied to the child rather than the contributor. If you go over the limit, you or another contributor may have to pay a penalty of 1% each month on excess contributions.
It may make the most sense for all interested adults to contribute to the same RESP, regardless of who sets it up initially, or it may be better, if somewhat more work, to diversify by having two or more for one beneficiary, invested differently.
As an incentive to save for education, the federal government matches the first 20% (up to $2,500) of contributions each year, up to $500 per year per child, with a lifetime limit of $7,200 per child, in the form of Canada Education Savings Grants (CESGs).
Additional government funds for RESPs are available to low-income families, including the federal Canada Learning Bond (up to $2,000 per child), and the provincial Quebec Education Savings Incentive (in the form of a refundable tax credit). Furthermore, all residents of B.C. are eligible for the British Columbia Training and Education Savings Grant ($1,200 per child). The beneficiary's parents/legal guardians must apply for these benefits.
When the child enrolls in university, college, or another eligible post-secondary training program, they can use the funds in the RESP to pay for any education-related expense, including tuition, books, supplies or transportation.
There's no tax deduction for you in contributing to an RESP; rather, interest or investment income will accumulate tax-free inside the account.
Can I name more than one beneficiary to an RESP?
If the beneficiaries are (by blood relation or adoption) your children, stepchildren, grandchildren, brothers or sisters, you can open a family RESP, which allows you to name more than one beneficiary. So if you are a grandparent and have multiple grandchildren that you'd like to save for, you can do so all under one family RESP. (Note that the contribution and CESG limits per child still apply.) If you are an aunt, uncle or cousin, or unrelated to the child, you would instead need to open a separate individual RESP for each child you want to save for.
How are RESPs taxed?
You don't get a tax deduction when you contribute to an RESP, so withdrawals of contributions, referred to as post-secondary education (PSE) withdrawals, are not taxable when they are withdrawn — any tax owing on that money has already been paid!
Only investment earnings and CESG funds are taxable when withdrawn. These withdrawals are called education assistance payments (EAPs) and are taxed as income in the student's hands.
However, the student may not end up paying any tax at all, because students often have little to no other income, and can claim tuition tax credits.
What if all the money in the RESP isn't used?
RESPs can stay open for 35 years, so there's lots of time for beneficiaries to make use of the funds. If they don't use it all within that timeframe, money remaining from your original contributions is returned to you tax-free. Unused CESG money can be shared with a beneficiary's siblings, assuming they have grant room available —otherwise, CESG funds must be returned to the Government of Canada.
Finally, any unused investment earnings are added to the contributor's income and taxable at their marginal rate, plus 20% — or you may be able to transfer these funds to your or your spouse's RRSP, if there is contribution room remaining, to limit your taxes owing.
2. Cash gifts
If you're concerned about a potential tax hit on any unused investment earnings remaining in an RESP, there's a simple workaround: instead of contributing directly to the child's RESP, gift the money to the child's parents or legal guardians and let them make the RESP contributions on your behalf. As mentioned previously, Canada has no gift tax — which means they can receive the money without it affecting their tax situation — and you'll be protected from any future taxes as well.
3. Registered retirement savings plan (RRSP)
It's not an obvious solution, but if the child has already started working (even at part-time or summer jobs), you can help fund their education by contributing to their RRSP. Under the Lifelong Learning Plan (LLP), full-time post-secondary students can withdraw up to $10,000 in tax-free funds from their RRSP annually (with a lifetime maximum of $20,000).
How to contribute to a child's RRSP
There is no minimum age for opening an RRSP, so the child would open the account themselves (minors need the consent of a parent or legal guardian). Once they begin working and filing annual tax returns, they automatically accumulate 18% of the previous year's earned income in RRSP contribution room. You can then put money into their RRSP, up to their contribution limit.
Who gets the RRSP tax deduction?
Since the contribution is made to the child's RRSP account, they will get the tax deduction. But they don't have to claim the deduction right away. In fact, deductions on RRSP contributions can be deferred to any future year — so it may make the most sense for them to wait until after they've completed their schooling and are earning income in a higher tax bracket to claim those deductions. They can then use those extra funds to repay the LLP or pay down student debt more quickly than they could on their own.
Pros and cons of gifting money through a child's RRSP
When you contribute to a child's RRSP, they can benefit in a few ways:
- The money will earn interest or investment income, tax-free, for as long as it stays in the account — and can be withdrawn tax-free by the student, up to prescribed limits, under the Lifelong Learning Plan.
- They will be able to reduce their annual income taxes in the future when they claim the RRSP deduction(s).
- If they don't end up needing all the money for their education, they can also access up to $35,000, tax-free, under the Home Buyers' Plan (HBP) if/when they are ready to purchase a home.
Potential drawbacks include:
- Tax-free withdrawals from an RRSP under the LLP or HBP are limited to $20,000 (total) and $35,000, respectively, and must be repaid within a certain number of years to remain tax-free.
- If they claim the deductions for RRSP contributions when they are in a low-income tax bracket, they may end up paying more in taxes when they draw the funds in retirement than they saved from the tax deduction.
4. Tax-free savings account (TFSA)
Canadian residents start accumulating TFSA contribution room at age 18, so this is another great way to help fund an older student's education while sheltering the interest and/or investment income from tax.
One advantage to a TFSA is that if the child's RESP limit has already been reached, perhaps by their parents or guardians, this allows you to contribute more each year for their future.
Another is that there are no limits on when, or how, withdrawals can be used. Nobody likes to think about the possibility that a child will face a life-changing challenge — physical, mental, or another kind entirely — that puts not just their education but their entire future into question, but as physicians know all too well, it can happen.
Knowing that the funds you contribute now will be available quickly without conditions or penalties in that situation can be a great comfort.
How to contribute to a young adult's TFSA
The young adult would open their own TFSA, and have contribution room available; you can then transfer money into the account up to their limit each year.
Can I save for a child's education in my own TFSA?
Yes — if you haven't maxed out your own TFSA, you could open a separate TFSA account under your name for the purposes of saving for a child's education. In this case, the child can be a minor — you can even name them as a beneficiary of the account in case you die before they need the money. When they are ready to pay for school, the money can be withdrawn tax-free.
If you want to add conditions to your gift — say, for example, providing money for graduate studies only—you could consider setting up a living trust. A living trust (also called an inter vivos trust) is a trust in which the assets are given to the beneficiary while you're alive (as opposed to after your death). A trust lets you set the parameters for when and how the beneficiary can access the funds.
A living trust on its own, however, doesn't offer the same financial advantages that you get from registered accounts. On the contrary, you must pay a lawyer to create a living trust and a trustee to manage the assets.
Also, it's important to be cautious in setting conditions on gifts: remember that your goal is to help someone you care about thrive, not to exert undue influence on their life and career choices. A too-restrictive trust is a recipe for frustration on your part and resentment on theirs — so be sure before you choose this path that you and the child, not just you and the parents or guardians, are on the same page.
The bottom line
Consider the child or student's age, tax implications and other factors outlined above before choosing a method for contributing to their education. Then, sit back and take pride in your loved one's accomplishments!
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.