Save for college now - or later?
Start a long-term plan now, arrange a loan when it's time or pay as you go
Jonathan Chevreau
Financial Post
With the multiple demands on our pitiful after-tax disposable incomes, excuses not to divert savings in some direction are always welcome to strapped Canadian wage earners.
Forthwith the most popular excuses to avoid saving for your child's education, courtesy of Benjamin McLean, author of Guarantee Your Child's Financial Future (Toronto: McGraw Hill Ryerson, 1998):
- My children can work their way through university or college.
- Scholarships; we're raising a bright kid.
- Bursaries are available.
- Employer assistance can help.
- Canada Student Loans are a great deal.
- The banks have opened up lines of credit designed for students.
- I'll pay as they go.
- I'll remortgage the house.
- Let the kids run up their student debts. The government will forgive the loans anyway.
Excuses aside, responsible parents who care about their kids' future education really have three methods for paying the not inconsiderable costs of a college education. Mr. McLean lists these as Heartbreak Hotel, Self-Sacrifice and Small Change.
If you have a three-year-old child and the goal is to send him or her away for four years of university living away from home, then the Heartbreak Hotel route of paying later will cost $116,713, Mr. McLean calculates. That assumes borrowing costs of 8% and the loan is repaid in eight years at $1,216 a month.
The Self-Sacrifice route of paying the college costs as you go over the four years involves paying out about $21,500 per year, for a total cost of $86,000.
Then there's the Small Change approach of advance planning by saving up years before the money has to be accumulated. By investing $226 a month of $2,707 in a registered education savings plan (RESP) earning 10% a year, the total cost will be just $40,605.
And, of course, the government helps you further by providing the 20% Canada Education Savings Grant (CESG) for the first $2,000 RESP contribution per child per year. That works out to $400 per child per year.
The CESG -- introduced in last year's federal budget -- can be generated by either of the two main form of RESPs: self-directed RESPs (available from mutual fund companies, banks and trust companies) and traditional scholarship-trust RESPs, sold directly by private, non-profit organizations.
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Self-directed plans: Based on the numbers of pros and cons he assigns to the two RESP types, Mr. McLean appears to favour the self-directed variety.
The only two cons he comes up with for the self-directed plans are that the capital is not guaranteed (if in equity mutual funds, for example) and that they may require some continuing investment decisions. Among the six pros are that self-directed RESPs have flexible beneficiary rules.
Scholarship trusts: He lists five cons for scholarship trust RESPs:
- Because they are cash or fixed income, growth may be only modest.
- Enrolment fees are paid upfront and can be relatively high.
- If you stop investing you may only receive your contributions less administration fees and penalties, with your earnings staying in the pool (or tontine) for other students.
- Final unit values will be partly determined by the number of students remaining in the pool.
- The plan may insist on continuous studies; scholarship funds may cease if the student takes time away from school.
On the plus side, contribution limits may be as low as $10 a month and the newer plans have greater flexibility.
There are, in addition, four main alternative savings methods that do not qualify for the CESG:
Informal in-trust account: This was popular before the grant was introduced. Such accounts normally held equity mutual funds. Among their pros are that capital gains taxed in the child's hands have minimal tax liability and that second-generation income is taxed in the child's hands. The cons include tax liability for first-generation income, a loss of control of assets when the beneficiary reaches the age of majority and possible breach of trust if the asset are not used for the beneficiary.
Living trusts: Also known as inter vivos, this type of trust allows guardians to transfer legal title of assets (including shares in a business) or contribute cash to a trust with instructions to the trustee about how the assets are to be managed for the beneficiary. Mutual funds and other investments can be held, among other securities, and -- unlike RESPs -- there are no limits on when the trust can be opened or how old the beneficiary has to be.
Your contributions to the trust belong to the child, but the funds don't necessarily have to be used for education: They could also be used to launch a business or to buy a home, depending on the exact terms of the trust. Mr. McLean suggests a $100,000 minimum and warns there may be some tax liability to consider.
Non-registered education savings plans: Many Canadians start saving for their kids this way, although they do not get the tax-deferred earnings of an RESP and they don't get the CESG. But there are no contribution or age limits and the money can be used for anything if the account is in your name.
Cash-value life insurance: This is a life insurance policy combined with a savings or investment component. There is no tax liability on earnings until they are withdrawn and, in the event of death, the benefit is tax free. But there can be a large penalty if cancelled in the first two years, and surrendering the policy to get the cash value cancels the insurance and can trigger taxable capital gains.
While Mr. McLean's nine excuses were clearly written with his tongue planted firmly in his cheek, he nonetheless draws upon some of them in a later chapter he calls a 24-month plan.
Mr. McLean does not necessarily endorse the route of pre-funding the entire education and handing it gratis to the child. Rather, he suggests that parent and child create a concrete plan approximately two years before the planned commencement of post-secondary studies. The plan consists of five steps he says will result in paying dramatically less for their education than other students entering their first year.
1. Consider tutoring to get the high grades necessary for a scholarship, start grant research early and consider part-time work.
2. Research the university or college that offers the best value and financial aid package of scholarships, bursaries, co-op and work-study programs and local part-time job opportunities.
3. Perform thorough research of all sources of free money (such as www.parentsguide.com) and government grants.
4. Get rolling on the Canada Student Loan program (380,000 students or 30% of all students used this in 1998). Also, investigate provincial student loan programs, lines of credit at banks and other financial institutions and research the qualifications for the new Canada Millennium Scholarship Foundation.
5. Prepare for the unexpected hidden or extra costs once school begins, such as tuition increases, transportation, food, tutors and personal computing/Internet access.