Psst! Got $150,000 for a college degree?
Higher university fees? As they say in showbiz, you ain’t seen nothin’ yet! If your child or grandchild were born today, the latest projections show your family will need somewhere in the neighbourhood of $150,000 to pay for their basic, ordinary, nothing-fancy, four-year undergraduate degree.
Of course, none of this is a secret to Ottawa and the provinces. It’s why Finance Minister Paul Martin sweetened the education savings pot in his last two federal budgets. The changes make registered education savings plans (RESPs) more attractive, although probably not enough to provide adequate funding.
If you have young children or grandchildren, your first step is to open an RESP. You can’t deduct contributions for income tax purposes, but taxes are deferred on income earned. Future payments go to the student, whose tax rate will almost certainly be much lower than yours. Since they will have little or no income, they’ll probably pay no tax at all.
This past February, Martin introduced a new program called the Canadian Education Savings Grant. Effective Jan. 1 of this year, any contributions made to an RESP for a child 17 or under will result in a grant from the government of to $400 per child per year. The cash from the grant will be deposited directly into your savings plan, helping it grow that much faster.
This comes on top of two improvements made in the 1997 federal budget. First, the limit on annual contributions per beneficiary was doubled from $2,000 to $4,000. The overall lifetime limit remains at $42,000, so this change is most helpful for those who start saving when their children are older.
Second, if the child does not go to university, the income from the plan can be rolled into your RRSP, provided you have available contribution room. Previously, such income was lost, with interest staying in the pool for the benefit of other students.
RESPs are certainly more attractive now, but some people will still find them restrictive. How many are likely to have anywhere near the $50,000 of RRSP room they’ll need in their late 40s or 50s, when this situation is likely to arise?
You can withdraw RESP earnings if your child does not go on to university, but at tremendous cost. The money is treated as income in the year received, taxed at your marginal rate plus a 20 per cent penalty. You could end up paying a horrendous 70-75 per cent on money taken out this way.
An interesting alternative, or addition, to an RESP is to save through a mutual fund investment plan. There’s far greater growth potential over the years, the money can be used by the child in any other way if he or she decides not go to university, and you can take out all or part at any time – for example, in a financial emergency.
Although earned interest or dividends would be attributed to you for income tax purposes, capital gains are deemed to belong to the child. So this sort of education savings program should focus on mutual funds that target long-term capital appreciation – which is what most equity funds are all about in any case.