Monday's federal budget introduced a new planning complexity for those who
wish to save for their children's education through registered education savings
plans (RESPs).
The government has proposed two major changes to the contribution rules for
RESPs: the elimination of the $4,000 annual RESP contribution limit and the
increase of the lifetime RESP contribution limit to $50,000 from $42,000.
The Canada Education Savings Grant (CESG) rules are also changing. The
maximum annual contribution that will qualify for the CESG will be increased to
$2,500 from $2,000. Since 20% of this amount is contributed by the government in
the form of a grant, this increases the maximum annual CESG per beneficiary to
$500 from $400 per year.
CESGs are retroactive to 1998, so a beneficiary who did not receive a grant
in a prior year can now collect up to a maximum of $1,000 of CESGs in one year
based on a $5,000 RESP contribution. However, the $7,200 maximum lifetime CESG
remains unchanged.
The new ability to contribute a lump-sum of up to $50,000 (up from the
previous $4,000 limit) in a single year to an RESP opens up a new opportunity
for those who have the cash to jump-start a child's post-secondary education
savings.
The problem with this is that you waive your ability to collect CESGs in
future years. In other words, for a parent who has never opened an RESP for a
child, a contribution of $50,000 to an RESP today entitles the child to the 2007
CESG and one prior year's CESG, for a total of $1,000. No future CESGs would be
available.
Do the benefits of tax-deferred compounding for the life of an RESP -- around
25 years -- outweigh the loss of future CESGs? It depends on a number of
factors, including the child's age, the type of investment (income, dividends or
capital gains) and the rate of return.
It also depends on the parent's tax rate. If you have a lump sum of $50,000
to put into an RESP, there's always the alternative strategy of investing the
$50,000 in a non-registered account for the next 25 years. For a conservative
investor at the highest marginal tax rate, who would most likely invest in
highly taxed interest generating products, the benefits of sheltering 25 years
of interest income inside an RESP can outweigh the loss of the CESGs.
On the other hand, if a parent put that same $50,000 into tax deferred
investments that generate capital gains when ultimately sold, it may prove more
worthwhile to invest $2,500 annually into an RESP in order to collect the $500
annual CESG.
Jamie Golombek, CA, CPA, CFP, CLU, TEP is vice-president,taxation and estate planning, at AIM Trimark Investments in Toronto.
jamie.golombek@aimtrimark.com