The recent doubling of the TFSA limit to $10,000 (which means $20,000 for a couple) opens up even more choices for Canadians in their attempt to maximize tax-preferred savings. But, given the recent survey released by the Chartered Professional Accountants of Canada this week, which found that only 53 per cent of parents surveyed have a Registered Education Savings Plan for their kids, maybe some Canadians are too enamoured of TFSAs and have neglected to top up their RESPs.
This is unfortunate, because RESPs still remain the best possible way to save for college or university.
In many cases, RESPs behave very similarly to a TFSA.
For example, both RESPs and TFSAs are funded with after-tax dollars. Both plans can be invested in a variety of products, such as GICs, mutual funds, stocks and bonds, and both allow the income and growth in the plans to accumulate tax-free. Finally, while TFSA withdrawals are, by their very nature, tax-free, in many cases the RESP also provides what are effectively tax-free withdrawals.
A world with TFSAs vs without: Guess which can help a middle-class couple save $1.1M?
That’s because the RESP contributions come out tax-free and the balance, referred to as Educational Assistance Payments, are taxable to the student, who likely won’t end up paying any tax on EAPs withdrawn owing to the available personal tax credits – e.g. basic personal, tuition, education and textbook amounts – estimated to total over $21,000 annually, assuming tuition of $6,000.
That’s where the similarities end. RESPs come with a kicker: free money in the form of the Canada Education Savings Grant. CESGs are generally paid at a rate of 20 per cent of annual contributions up to $2,500 for an annual maximum of $500 per child, assuming no unused grant room is available from prior years. To maximize the total CESGs you are permitted to collect over a child’s youth, you would need to contribute at least $2,500 annually for about 14.5 years to obtain the full $7,200 of CESGs available per child (i.e. 14.4 X $2,500 X 20 per cent).
So, if you’ve got kids under 18 and there’s even a remote chance that they will attend post-secondary education, my advice would be to contribute the $2,500 annually for each child to maximize their CESG before even touching the TFSA.
Let’s take an example of an Alberta family, with two kids, who earn $120,000 split evenly between two working parents. Ignoring specific tax credits for things like public transit and children’s fitness activities, their family tax bill would amount to about $25,000 leaving $95,000 after-tax.
Let’s assume the balance on their five-year fixed rate mortgage at 2.99 per cent is $500,000 and their monthly payments are $2,364. That means they are contributing about $28,000 annually to pay down their debt.
After deducting mortgage payments from their after-tax income, the couple is left with $67,000. If they were to maximize the RESPs to the tune of $2,500 per child, that leaves $62,000 to meet all the family’s expenses, including additional savings.
Clearly, trying to sock away the full $20,000 into TFSAs isn’t realistic. Which is why it’s important, especially early in the calendar year, to set up a budget, which includes not only the monthly expenses, such as groceries, utilities, property taxes and so forth, but which also includes a monthly savings component.