Every parent dreams of the day their children go off to college. After all, it's a defining point in everyone's life. But let's face it, going to college or university costs a lot of money. So it makes sense to have a plan to save up for this very important life event. 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 Canada 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. Read on to learn more about this program and how it differs from the 529 plans available to American parents.
- The Canadian Education and Savings Grant is an incentive-based program where the federal government matches contributions made to an RESP up to a certain percentage.
- Contributions are returned if the beneficiary doesn't attend a post-secondary institution within 36 years of the date the account is opened.
- Parents aren't subject to taxation on invested contributions but they are taxed on investment earnings withdrawn from the RESP and not used for educational expenses.
- 529 plan contributions are made with after-tax dollars, where accumulated earnings grow tax-free at the federal level.
What Is the CESG?
The Canadian Education and Savings Grant is an incentive-based program that allows Canadians to receive a grant for the money they save for a child's education, whether that's a parent, another family member, or a friend. Here's how it works.
Parents open a Registered Education Savings Plan (RESP) at a bank, credit union, or other financial institution. As mentioned above, anyone can contribute—a parent, aunt, uncle, friend, or grandparent. Since an RESP is an investment account, there may be 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 the RESP. This matching contribution is what makes up the Canadian Education and Savings Grant. The program provides a 20% base batch on the first $2,500 of contributions for all families, for a maximum grant of $500 per year. Lower-income families may qualify for additional grants. For 2020, families that earn between $48,535 and $97,069 are eligible for an additional 10% grant on the first $500. Those with adjusted family incomes below $48,535 may receive an extra award of 20% on the first $500. Each child can earn up to $7,200 in lifetime grants.
Parents are not able to deduct contributions on their income taxes. However, earnings are not taxable as long as they stay within the RESP.
Student RESP Paychecks
Once the beneficiary is enrolled in an approved post-secondary institution, they receive payments called educational assistance payments (EAPs) from their RESP. Unfortunately, students who receive funds from an RESP must pay income tax on those payments. But 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.
But there is one catch. The child must pursue an approved post-secondary education training program, such as college or trade school, within 36 years of opening the account to get full benefits. The contributions are returned if the beneficiary doesn't go to school and the government will take back the grant money. But the money may not be entirely lost since the account holder may be able to transfer the balance to another child.
You don't have to pay income tax on the contributions you invested. However, any investment earnings 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 an RESP
Even a few dollars per week adds up quickly. For instance, investing $9.62 per week adds 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. If grant levels remain the same, you may receive as much as $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 an 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 offer state tax deductions for parental contributions. Most states though, don't have grant-matching programs, though a handful offer amounts ranging between $100 to $500.
Remember—your state may offer tax benefits for 529 plan contributions and withdrawals aren't subject to federal income taxes when used to pay for qualified higher education expenses.
There are two types of 529 plans available—the college savings and prepaid tuition programs. 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 individual retirement account (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 Setting Every Community Up for Retirement Enhancement (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. Keep in mind there are contribution limits for 529 plans that vary between states. Fortunately, these limits are quite high. The ceilings were between $300,000 and $500,000 per beneficiary.
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.