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Written by: Bryan Hubbell, CPA, CGA
As children return to school, many parents are faced with the question of how they will fund their children’s post-secondary education. For illustration purposes, let’s assume that the annual cost to attend university is $30,000, which includes tuition, books and living expenses.
Some of these costs can be recovered through tax credits claimed by the children and parents.
Students can claim non-refundable tax credits for eligible tuition fees and a prescribed amount for each month of qualifying full-time or part-time attendance at classes. The eligible amounts are reported by the school on Form T2202A for students attending university in Canada or Form TL11A for students attending university outside Canada. In this Internet Age, students often need to log into their school’s website to download these forms (the schools no longer distribute hard copies by mail).
Students can use the available tuition and education tax credits to eliminate their income taxes payable. Any excess credits can be carried forward for use in subsequent years and up to $5,000 of tuition and education amounts earned in the year can be transferred to a parent. This reflects the fact that the student’s parents may be funding the cost of the student’s university education. The maximum tuition and education transfer translates into approximately $1,000* of tax savings to the student’s parents.
Registered Education Savings Plans (RESPs) can be a useful tool for parents who still have many years to save for their children’s university education.
Annual contributions to an RESP are eligible for the Canada Education Savings Grant (CESG). The basic CESG is 20% of annual contributions to an RESP for a qualifying beneficiary up to a maximum annual amount of $500 (up to $1,000 in CESG if there is unused grant room from a previous year), subject to a lifetime maximum of $7,200. An enhanced CESG is available for contributions to an RESP for the benefit of children of lower income families**.
While annual contributions to an RESP are not tax deductible, the CESG and the investment earnings inside the RESP accumulate on a tax-deferred basis. The CESG and investment earnings are taxable in the hands of the student when the funds are withdrawn to fund their university education. Often RESP beneficiaries have little other income so it is possible that no income tax is payable on the RESP withdrawal.
With an RESP, the student’s annual university education costs are funded through a combination of non-deductible contributions by the student’s parents, the CESG and investment earnings.
Parents who have not established RESPs for their children, or have not accumulated sufficient RESP savings may need to fund their children’s university education out of current cash flow.
Assuming a personal marginal tax rate of 44%, an additional salary of $51,800 would be required for a parent to fund their child’s annual university cost of $30,000. This is illustrated as follows:
|Salary Needed to fund education costs
|Less: Personal income tax @ 44%
|Add: Tuition and education credit transferred from child ($5,000 @ 20%)
|Net cash to fund education costs
Family business owners who have introduced a family trust into their business ownership structure can fund their children’s university education through the family trust. Doing so can reduce the cash flow needed as follows:
|Corporate net income to fund education costs
|Less: Corporate income tax @ 13.5%
|Dividend to family trust, which is allocated to students
|Less: Personal income tax paid by student***
|Net cash to fund education costs
Bryan Hubbell, CPA, CGA is a Senior Tax Manager with Manning Elliott LLP. Contact Bryan at 1-604-557-5759 or firstname.lastname@example.org
*The personal non-refundable tax credits are calculated at the lowest personal tax rate. For 2015 the combined federal and provincial rate for personal non-refundable tax credits is 20.06%.
**Families with qualifying net income of $43,953 or less are eligible for an additional 20% CESG on the first $500 of annual RESP contribution. Families with qualifying net income of more than $43,953 but less than $87,907 are eligible for an additional 10% CESG on the first $500 of annual RESP contribution.
***Assuming the student has attained the age of 17 before the year and has little or no other income, the non-refundable tuition and education credits and dividend tax credit will eliminate any income tax payable by the student.
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.