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.
If you are focused on giving your children the best possible financial future, then you are probably interested in discovering the best savings vehicles available in Canada.
There are many different savings accounts, assets, and qualified investments you can use for savings purposes, from dropping a few spare coins in a piggy bank to purchasing thousands of dollars of stock and bonds. But, often the best and most practical way to achieve the best result when saving for your kid’s future, is to find a form of savings that is tax-free.
Tax-Free Savings Account
While many investments may appear to be tax-free, be sure to read the small print.
Tax deferred is not tax-free, it means you pay the tax later rather than right now.
Other investments are tax-free because the money invested can only be used for one specific purpose only, like your child’s education, or cannot be accessed until a specific period has passed, like retirement.
The number of truly tax-free savings options in Canada that are flexible enough to meet your child’s future financial goals is very small.
Many investments like property or stocks seem like a great way to save for your children’s future, but you need to be aware of the impact of Capital Gains Tax.
A capital gain is where you have bought an asset (which could be real estate, a stock, or a mutual fund investing in stocks or property), and you sell it for more than you paid for it.
You will need to calculate 50% of the capital gain and add that to your income.
Capital gains can be offset by capital losses. This would mean selling an asset for less than you bought it for, which defeats the purpose of purchasing the asset in the first place.
Calculating capital gains and losses can get quite complex and time consuming.
Using Mutual Funds for long term investment goals is sound advice as they have many advantages. They enable you to access a wide range of investment markets and assets which reduces your investment risk, and you can do this with quite small contributions.
They work by having large numbers of investors pooling their funds together into an investment vehicle that might buy many different assets including bonds, stocks, property and/or money market investments. You have professional Fund Managers making the investment decisions but working within benchmarks specific to each mutual fund.
For example, a balanced mutual fund might invest 10% in money market investments, 35% in bonds, 15% in property and 40% in stocks, with the ability for each asset class to hold up to 5% more or less than those benchmarks.
This means if the stock market is underperforming the fund managers might sell off stock to get down to a 35% holding, but they can go no further. And if the stock market is performing well, they could increase the holding to 45%, but can go no further.
This ability to diversify has the benefit of reducing investment risk but can also sometimes limit potential gains.
However, mutual funds do incur tax. The interest you gain from bonds and money market investments will be taxed at your marginal tax rate.
Dividends and capital gains are taxed at a lower rate but are still taxed.
As well as having to pay tax on mutual funds, it is also quite complex and time consuming to work it all out in your tax return, especially if you have more than one mutual fund.
What is a Tax-Free Savings Account in Canada?
The Tax-Free Savings Account (TFSA) program began in 2009. It is a way for individuals who are 18 years of age and older and who have a valid social insurance number (SIN) to set money aside tax-free throughout their lifetime. Contributions to a TFSA are not tax deductible for income tax purposes. Any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn.
Pros and cons of TFSAs
When we start educating ourselves on TFSAs, it’s easy to see how they work. Although the TFSA has been beneficial to many, there are some drawbacks.
TFSAs can also provide a variety of other financial assets for retirement savings. You can invest with a mutual fund, stocks, bonds and guaranteed securities. While you can’t claim tax breaks you will not have income taxes. TFSAs allow you to keep a tax-free account with less than a dollar amount in it.
- Tax-Free Growth – any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn.
- You can withdraw at any time and use the money for anything.
- Share Contribution Room with A Spouse – for a couple, this means your yearly limit is $12,000 if you share the TFSA.
- ·You can carry forward unused contribution room from previous years – if you make a withdrawal in the current calendar year, the amount of your withdrawal is added to your unused contribution room.
- Withdrawals Won’t Impact Government Benefits.
- No Tax Upon Death.
- No Barrier to Withdrawals – if other expenses come along, you might spend what you’ve saved and have nothing left for the specific savings goal you had intended to use the TFSA for.
- No Income-Tax Reduction.
- No Protection from Creditors – if you get into financial difficulties, these savings can be taken by creditors.
- Over-contribution penalty – any contribution beyond the maximum allowable amount is considered an over-contribution. The Canada Revenue Agency (CRA) will charge a penalty of 1% per month on the excess contribution until it is withdrawn.
How Tax-Free Savings Accounts Contributions Work?
Contributions are sometimes challenging because different variables are dependent on individual circumstances. There are limitations for contributions each year. In the 2022 tax year, TFSA contributions will be limited to $6000. If you contribute less than the limit, the shortfall can be carried forward to later years.
A TFSA could be used to meet many savings goals as well as gifting some or all your account to meet your children’s financial goals as they arise. It could be used to fund their post-secondary education, a deposit on a first home, overseas experience, buy a business, etc.
There is the danger that some other need of your own comes along and takes precedence over your child’s financial goal. And if you have more than one child, how do you treat each equitably?
Child Plan ™ – Whole Life Plan
Child Plan ™ can be used for any financial need in your child’s lifetime, but it also doubles as an education fund. Considering it can be opened just 14 days after birth, Child Plan ™ gives you so much more time to begin, and then finish, saving for your child’s post-secondary education.
However, it could also be used for a down payment on a home, starting a new business, or to provide financial security for their own family, or for any other purpose. You cannot make withdrawals before the child is 18, and the plan can never be taken by creditors.
The annual tax-free dividend provides unrivaled financial security and Child Plan ™ is permanently funded after 20 years. One of the biggest differences between Child Plan ™ and a child education fund is that it is a Whole Life Insurance plan, so your child will be permanently covered.
Child Plan ™ is the fastest growing alternative to RESP. Its gains are non-taxable, you can make withdrawals from the cash value after your child turns 18 years, and you have the option of continuing the plan, with or without regular contributions, until the death of the Life insured (the child).
Any time after your child turns 18, you can transfer ownership over to them. If the plan is still in place at the time of the child’s death, Child Plan ™ will pay out the sum insured. The sum insured will be a far greater value than the cash value.
To see how the cash values and sum insured increase over time, you can request an illustration from https://www.insuranceforchildren.ca/request-illustration.
To learn more about Child Plan ™, please visit insuranceforchildren.ca.