While Americans can save for their children's education in a tax-advantaged investment plan, Canadian children can have grants awarded to them at birth. Through the Canadian Education Savings Grant (CESG), parents can start saving for their children's education literally at day one. Even better, the Canadian government will pitch in for part of the tab.
How the CESG Works
Parents can open up a Registered Education Savings Plan (RESP) at a bank, credit union, or other financial institution. Anyone can contribute, whether it's mom, dad, or a favorite aunt or uncle. Since a RESP is an investment account, it could have fees attached. Parents should be careful to choose one that's right for their children.
The government then matches the money up to a certain percentage and deposits it into your child's RESP. The extra funds the government deposits are called the Canadian Education and Savings Grant. For 2019, the base match was 20% on the first $2,500 of contributions for all families. The maximum grant was $500 for high-income families. Families making between $47,630 and $95,259 were eligible for an additional 10% grant on the first $500. Those with adjusted family incomes below $47,630 could get an extra award of 20% on the first $500. Each child can earn up to $7,200 in lifetime grants.
Parents won't initially pay taxes on the money, so they have a double incentive to save for their child's education. They avoid paying taxes and get bonus money for the child's education in the process. There are many other tax breaks for Canadian families.
Student RESP Paychecks
Once the beneficiary is enrolled in an approved postsecondary institution, they will receive payments called educational assistance payments (EAPs) from their RESP. Unfortunately, students who receive funds from a RESP will pay income tax on those payments. However, the taxes they pay will likely be a lot less than what parents would have paid on the same money because students usually aren't raking in a lot of cash.
The child must pursue an approved postsecondary education training program, such as college or trade school, within 36 years of opening the account to get full benefits. If the child does not pursue an education, your contributions will be returned. However, the government will take back the grant money. You may also be able to transfer the balance to another child.
You will not have to pay income tax on the contributions you invested. However, any investment earnings that are withdrawn from the RESP and not used for education-related expenses are subject to income tax and a 20% penalty tax. These payments are called accumulated income payments (AIP).
Affording a RESP
Even a few dollars per week adds up quickly. For instance, investing $9.62 per week will add up to $500 in a year. If you met the income requirements, this amount is matched at $200. In one year, you would have saved $700, before interest, for your child.
If you started doing this at year one of your child's life, your contribution would be $8,500 before earning any interest. You could receive, if grant levels remain the same, $3,400 from the government. Your son or daughter would end up with a base amount of $11,900 for education. Depending on your investments, that could grow to a substantial sum with compounding.
There are also grant programs, where you can get more money for your RESP from the government if you meet the income requirements. For example, your child could be eligible to receive a $500 Canada Learning Bond. If you continue to meet the requirements, you can receive another $100 per year to fund your child's RESP until they hit age 15. No personal contributions are required, and you can receive a maximum of $2,000 from Canada Learning Bonds.
How Does the American 529 Plan Compare?
The American 529 plan is similar to a RESP in that it is an investment vehicle for parents to contribute to their child's education. Contributions made to 529 plans are made with after-tax dollars, and the earnings accumulated in the plan grow tax-free at the federal level.
The biggest advantage of this structure is that you end up paying no taxes on your withdrawals if they go to qualified education expenses. However, you make contributions with after-tax dollars. That means high-income parents pay a higher tax rate on their contributions than the student receiving the money would have paid. On the other hand, the majority of states do offer state tax deductions for parents' contributions.
U.S. 529 plans are paid for with after-tax dollars and pay out tax-free. In contrast, Canadian RESP accounts are paid for with pretax dollars and tax withdrawals as income for your children.
As far as getting grant money on top of their investment, the 529 plan doesn't include grant-matching programs. There are two types of 529 plans available: college savings and the prepaid tuition program.
Prepaid tuition programs allow parents to prepay college tuition at today's rates. Prepayment can be very beneficial because of rising tuition rates in the United States. Suppose that a parent put in $2,000 this year to cover tuition for a semester of school 15 years from now, and tuition rose at a rate of 5% per year. The $2,000 invested today would cover $4,158 worth of college tuition. That is equivalent to receiving a $2,158 grant by locking in the tuition at today's level.
Investments in a college savings plan can fluctuate depending on the market, much like in an IRA or 401(k). There is a risk that the market will underperform, and you may end up with less money than expected. At the same time, there is also more potential for growth.
It is also possible to use 529 plan funds to pay down student loan debt thanks to the SECURE Act of 2019. However, only $10,000 can be used for repaying student loans. Furthermore, this $10,000 ceiling is a cumulative lifetime limit.
Also, be aware that there are contribution limits for 529 plans that vary between states. Fortunately, these limits are quite high. The ceilings were between $235,000 and $529,000 in 2019.
The Bottom Line
Both Canada and the United States offer programs parents should use when saving for their child's education. Don't stop with education savings plans. Within a year of college, students should also check out and apply for grants and scholarships from universities. After all, more support from universities means less student loan debt for students and their parents.