Saving for your child’s post-secondary education is one of the many financial pressures parents face. And when your child’s tuition will cost tens of thousands of dollars, you don’t want to give up a huge portion of your savings to taxes.
Fortunately, Canadians have a few options to shelter their investment earnings from tax. There are two popular options you can use to save for your child’s education: The tax-free savings account (TFSA) and the registered education savings plan (RESP).
Let’s start with the TFSA. A TFSA is a tax-sheltered account that lets you invest money tax-free. The way this works is simple. Unlike non-registered investment accounts that require you to pay income taxes on the money you earn, you never have to pay tax on the money you earn in a TFSA. You can hold all kinds of investments in a TFSA including stocks, bonds, mutual funds, exchange-traded funds (ETFs), GICs, and cash.
There are a few special rules to TFSAs, the most important of which is the TFSA contribution limit. You only receive a certain amount of contribution room each year (currently $5,500) and you start earning that room from the time you turn 18. So if you were 18 in 2009 when TFSAs were first introduced and you’ve never put money into one, you now have $52,000 of contribution room.
You can use a TFSA for any reason, including a child’s education. But when it comes to education, many Canadians choose to invest in an RESP instead.
Designed to help parents and caregivers save for their children’s education, RESPs work a lot like TFSAs. You can hold all kinds of investments in an RESP. And the money you earn is sheltered from tax. But rather than the withdrawals being tax-free, your child pays income tax on the money they withdraw from their RESP when they go to school. The advantage to this is they’ll likely be earning very little other income at the time and be in a very low tax bracket.
There are limits to how much you can contribute to an RESP: $50,000 for each child. This limit applies across all RESPs in their name regardless of who contributes to them (RESPs can be opened by anyone with a relationship with a child—not just the parents or legal guardians).
There’s another feature of RESPs that make them very attractive to parents—contribution matching.
The Canada Education Savings Grant (CESG) matches a portion of your contributions to your child’s RESP. Depending on the child’s family income, the CESG pays up to 40% on the first $500 of annual contributions and 20% on the next $2,000 (high-income families will receive 20% on the first $500 whereas lower-income families will receive 30% to 40% on the first $500 contribution). The maximum annual matching amount is between $500 and $600 but the lifetime limit per child is $7,200 for all families.
The Canada Learning Bond (CLB) is also available to low-income families as an incentive to open an RESP. It pays $500 in the first year of eligibility and $100 per year thereafter up to a total of $2,000 in grant money.
There are also a few provincial programs you may be able to take advantage of. Quebec, Saskatchewan, and British Columbia all provide supplemental grant programs to help families save.
With these grants, RESPs help you grow your child’s education savings much faster. Depending on where you live, how much the child’s family earns, and how much you contribute to the RESP, you can receive up to $13,700 per child in government grants.
Based on all the grants you can receive, the RESP appears to be the clear winner.
While you do have to use an RESP to save for a child’s education, there are no rules about how a TFSA can be used. If your savings goals are aggressive, you may decide to use both. For example, you can choose to contribute just enough to an RESP to earn the maximum grant and invest the remainder in a TFSA to reduce the child’s tax burden when they’re in school. (There’s no gift tax in Canada so you can take money out of your TFSA and give it to your children without worry of taxation.) You can also use a TFSA once the contribution room in your child’s RESP is exhausted.
You can get started with a TFSA or RESP just by opening an account at just about any Canadian bank, credit union, or discount brokerage. There are also online options that make investing very easy. To open an RESP, you’ll need to provide some information about the child including his/her social insurance number (SIN).
Whatever type of account you choose, the most important thing is to get started early. The sooner you start saving for your child’s education, the more time your investments have to grow. Even a regular savings account is better than nothing. Start by making a habit of saving and choose the type of account that will grow your savings fastest.
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