KNOW YOUR CLIENT: Ahead Of The Class
Get clients thinking about education savings and help their children reach for the stars.
What would you do if you knew of a product that could return 20% each year for 18 years, even in the safest of investment vehicles? Not possible, you may say. But consider how your clients may be able to take advantage of RESPs and the Canadian Education Savings Grant (CESG).
In 1998, the government introduced the CESG — a 20% grant on the first $2,000 in contributions to a child's RESP. In other words, if parents are contributing $2,000 to the children's education savings, there is $400 from the government just waiting to be snatched.
Kevin Williams, a Moncton, N.B.-based certified financial planner with Clarica, says he's seen some clever marketing from banks to attract clients to these "20% returns." But clients may be skeptical of RESPs because they are unaware of new rules introduced in 1998 and the CESG. The new plans are so misconceived," he says. Under the older system, if the child decided not to go to post-secondary education, the interest on the contributions was lost and parents needed to contribute to the plan on a fixed basis.
"Some clients remember the horror stories, but they don't realize how the new RESPs work," says Williams. Now RESPs can be self-directed, with lump-sum or fixed contributions, and be as aggressive or conservative as the client wishes.
RESP contributions are made with after-tax dollars, but the income generated in the RESP accumulates tax-free. When the child attends post-secondary education full-time, he or she can draw from the RESP. That income is added to his or her tax return, but students typically pay little or no income tax.
As education costs continue to rise, having a financial plan that includes education savings is becoming more of a priority for parents. "Parents are trying to do whatever they can to help their children pay for post-secondary education," says Monica Wagenaar, a certified financial planner with Edward Jones in Mississauga, Ont.
Carey Vandenberg, a financial planner with Partners in Planning Financial Services Ltd. in Vancouver, agrees and says encouraging parents of young children to contribute to RESPs is easy. "Some clients are asking even before they have a child," he says. "Some clients are looking at RESPs before their own RRSPs." The CESG is also a huge incentive to get parents on board. "Often the CESG is the primary motivator for anyone doing an RESP," says Vandenberg. "Anyone who has come to me wanting to start an RESP, it was because of the grant. If it wasn't there, they probably wouldn't do it."
Clients who recognize that their children will be going to a post-secondary institution usually want to start saving as soon as possible. "The biggest benefit is that there is a long time frame before the child needs the money," says Wagenaar. "A client can keep an RESP account open for 25 years. Since most kids will finish high school at age 18, chances are they would be out of post-secondary education before they are 25."
For those clients who may not have started an RESP for children as of yet, there are still opportunities. Whether a child has an RESP set up or not, they do have RESP carry-over room. Since January 1, 1998, each child who is a resident of Canada began to accumulate grant and contribution room. "A lot of advisors miss that, "Williams says. "Clients can invest $4,000 right now and use up their 1998 and 1999 space. Next year, they can invest another $4,000, which picks up 2000 and 2001 contribution limits." It wouldn't take too long to get all caught up and realize the grant for all the years missed. However, there are some exceptions for 16-year-old beneficiaries.
Clients can only contribute up to $42,000 per child into an RESP. They can also receive $7,200 in CESG over 18 years. The maximum that clients can contribute per year to receive the full grant is $2,000, but the grant and the contribution room does carry over from past years. In any year to play catch-up, the maximum grant would be $800.
Wagenaar says RESPs are a good way to get clients to start saving systematically. "If clients want to contribute in order to receive the maximum grant for a year, it works out to about $166 per month per child," she says. "From that standpoint, it gets people into the habit of saving on a monthly basis."
Williams likes to coincide RESP planning with tax season. "If a client puts $1,000 into an RRSP and is in a 40% tax bracket, he increases his tax refund by $400," Williams explains. "Then he turns around and puts $400 into an RESP for his child and receives an $80 grant. So, he's invested $1,000 into an RRSP for himself and gained $480 for his child."
Overall, Vandenberg says he finds that his clients are a little more conservative with the funds that they allocate for their children than with their own RRSPs. "It's amazing how much is just sitting," he says. "Some people would rather just gain interest than be in the market."
Whatever the investment strategy, Williams ensures that as children get closer to their post-secondary education, the money becomes more accessible. "It's important to move to fixed-income securities when the children reach high-school ages," he explains. "The money has a shorter time line then."
Grandparents also like to contribute to RESPs for their grandchildren, but Williams cautions that there may be some estate issues. "When the parents already have an RESP set up, I say to the grandparents, 'your son or daughter already has an RESP set up, why not contribute to that RESP?' " Otherwise, should the grandparent pass away before the grandchild draws the money out, the RESP may be subject to estate fees.
If the child decides not to pursue post-secondary education, parents can receive an accumulated income payment (AIP), if the plan has been in existence for at least 10 years, they are residents of Canada and all beneficiaries are over 21 and not attending post-secondary education. There is also a lifetime limit of $50,000 for AIPs transferred to an RRSP.
In-Trust Versus RESPs
RESPs aren't the only way to save for the future needs of children. In-trust accounts also allow parents to save for children. "Clients can get similar tax-deferral with the in-trust account with a little more flexibility," Vandenberg explains. "But at 18, the child has legal right to the account." He adds that he usually recommends that clients use the two options together, putting any money designated for the child In an RESP, up to $2,000, and the rest in an in-trust account.
Williams adds he hasn't done as many in-trust accounts since the changes to the RESPs. "Generally, there is no down side to an RESP," he says. "If the child doesn't use the RESP, the grant goes back to the government, but it wasn't the client's in the first place. The contributions are returned to the client tax-free because it is taxed money and the growth in the account is taxed at a higher tax penalty but it can be transferred to an RRSP for the client or a spousal RRSP." But getting clients investing in RESPs can secure an education for their children and reap a lifetime of success.
Jennifer McLaughlin is assistant editor of Advisor's Edge. firstname.lastname@example.org