This article is brought to you by Insurance for Children, Canada’s leader in financial planning for children and the creator of Child Plan ™ the fastest growing alternative to the RESP.
A new grandchild is a special occasion whether it is the 1st or the 10th grandchild.
Often there are gifts at the baby shower and further gifts after the birth. A new baby always means new miniature clothes, bibs, nappies, and sometimes home renovations for a new child’s nursery/bedroom.
But those are all short-term gifts.
As a grandparent you might be thinking what you can do to make a significant impact in this child’s life.
Perhaps something where you can save money, that will grow tax free, avoids capital gains tax and local taxes and avoids gift tax and estate taxes.
The child’s parents may not be in a financial position to do any more than cover the day-to-day costs of raising the child. They might be able to open bank accounts for their children and help the grandchild learn about money management, but you may be able to provide a financial gift that will have long-term benefits for the child.
You may be thinking, what kind of financial gift is the most appropriate for your grandchild?
With so many types of investment accounts like mutual funds and exchange traded funds available, finding the best financial products with the best tax breaks can be very confusing.
The Decision is Yours
Saving for your grandchildren is overwhelming and all options you have are yours. You cannot predict how long it will take to have a child grow into an adult. They may need to find some help in order to achieve their dream qualification. It’s your responsibility to choose where you want to invest in your grandchildren’s future. That’s your cash. Just keep in mind your grandchildren are probably thankful to have any kind of support they can get.
Registered Education Savings Plan
Registered Education Savings Plans (RESP) are a government-designated savings account at a financial institution enabling parents or grandparents to save for their child’s education after high school. This provides a limited option for this important financial goal and lacks flexibility if the child doesn’t take up post-secondary education.
What’s The Risk of Opening an RESP?
The big carrot that encourages many parents to contribute to an RESP is The Canada Education Savings Grant (CESG) which may add up to $500/year for each child, with a lifetime limit of $7,200.
What doesn’t get much attention in the promotion of an RESP is that:
- It can only be used for specific post secondary education courses.
- Applying to withdraw for eligible education expenses is often not straightforward.
- If the child does not attend one of the government-designated courses, the government grants are paid back to the Canada Revenue Agency, and the contributor gets their RESP contributions back, plus any investment gains which are taxed at their individual tax rate, plus a 20% penalty.
Tax-Free Savings Account
To open a Tax-Free Savings Account (TFSA) you must be over 18 with a valid Social Insurance Number (SIN). These are accounts held with financial institutions and registered with the federal government designed to help Canadians save.
The maximum amount you can be saving each year changes and there are penalties if you save more than the maximum amount. The amount for the current years is $6,000. If you did not put in the maximum amount last year, you can catch it up in future years.
Withdrawals are tax-free and can be used for anything.
With levels of financial literacy remaining extremely low in Canada, opening up a savings account for a child as soon as possible after birth makes good sense. Over time, having the account can help the child learn about the responsibilities of handling money, and set them up for a sound financial future.
The huge advantage of starting young and making regular contributions takes advantage of two of the most powerful concepts of modern portfolio theory.
Those concepts are the time value of money and the power of compound interest.
Simply put, the longer your savings are left to grow in any savings plan, the more it will grow in value because of the more interest it will earn. Then if you do not withdraw the interest earned, you begin earning interest on the interest!
This works even better if you invest over the long term too.
Child Plan ™ is suitable as a financial gift for a baby. It provides a Life Insurance sum insured and as you make your regular contributions, a cash fund grows that can be accessed any time after the age of 18 for your grandchild’s future.
This makes Child Plan ™ an ideal investment for funding post-secondary education, but the plan can continue with or without contributions to fund anything.
The grandchild could use the cash value of the plan as an adult for a deposit on their first home, to start up a business, or to fund their retirement! To see how the value of Child Plan ™ grows over time, put some figures into your illustration.
To learn more about Child Plan ™, please visit insuranceforchildren.ca.
Can Grandparents Open an RESP for Grandchildren?
Grandparents can open an RESP for a grandchild, each child can have multiple RESP accounts.
If the grandparents and the parents together contribute more than $2,500/year you do not attract any additional CESG money, and if together you contribute more than $50,000 in lifetime contributions you will have to pay a tax of 1% per month on excess contributions.
Alternatively, grandparents could offer to give money to the parents to put into their RESP for the child. This would reduce the risk of tax complications.
What Can RESP be Used For?
Once the child has enrolled full-time or part-time in a qualifying post-secondary educational program, you can request, on his or her behalf, to withdraw money from the RESP to help pay for their studies. Withdrawals are called Educational Assistance Payments.
To withdraw, contact your RESP provider. They will:
- require proof of enrolment
- ask for a list of allowable expenses that the money can be used for; and
- they may ask for receipts for purchases to prove the money is being spent on allowable educational expenses.
Your provider will provide you with guidelines for what is considered an allowable educational expense.
What Happens to RESP if Not Used?
There are five options to consider:
1. Leave the money in the RESP – it can remain in place for up to 36 years, so it is still available if the child returns to education later in life.
2. Replace the beneficiary – you may be able to use the money for the use of another child, check with your provider.
3. Transfer the money to your Registered Retirement Savings Plan (RRSP) – you may be able to transfer up to $50,000 of tax-free earnings. Some conditions apply, check with your RESP provider.
4. Close the RESP – the grants go back to the Canada Revenue Agency, but you get back your contributions and any investment growth, although you have to pay tax on that growth at your marginal rate in your tax return, plus a 20% tax penalty.
5. Transfer the money to a Registered Disability Savings Plan (RDSP) – there needs to be a common beneficiary, check with your provider. Of course this option only applies if you have a related grandchild with a disability.
Can Grandparents begin a Child Plan ™?
There are no contribution limits, complex investment options, or taxation complications. It doesn’t matter if the parents have also started other investments like a Child Plan ™ or an RESP.
What Happens if Child Plan ™ is not Used for the Child’s Education?
Child Plan ™ can be used for any purpose.
The plan remains in place, dividends continue to be distributed each year, and the cash value continues to grow (with or without contributions).
What can Child Plan ™ be Used for?
From the time the child turns 18 years of age, the policy owner can access the cash value of the plan at any time for any purpose.
You can continue to hold ownership of the plan, or transfer ownership to the child any time after they turn 18. So grandparents choose when to switch ownership to their grandchild.
Child Plan ™ is an ideal savings plan to be utilized for post-secondary education, but is not bound by the set guidelines of an RESP dictating where you must acquire your education and which expenses are allowable and which are not.
However, Child Plan ™ is also flexible enough to be used for any purpose the Policy Owner wishes to use it for. This could be a deposit on a first home, start-up money for a business, an overseas experience, a wedding, retirement funding, or a combination of these and any other major expense that might occur in the child’s future.