Estate and decumulation considerations discussed amid rising education costs
Back-to-school season comes with some scrambling. That might be scrambling to get the kids out the door on time, scrambling to make sure lunches are packed, or scrambling to prepare for a sudden increase in a post-secondary student’s cost of tuition, rent, or groceries. Advisors don’t usually help with the first and second tasks, but long-term planning and the use of Registered Education Savings Plans (RESPs) can often help clients deal with that third issue.
As with many registered accounts, however, RESPs can come with considerations, advantages, and drawbacks that aren’t always discussed. Sara Kinnear, Director of Tax & Estate Planning at IG Wealth Management talked through some of the key areas advisors should be aware of, the easy mistakes to make, and the long-term implications of these tools in a wider education savings plan.
“The starting point when you establish an RESP is always going to be determining who the subscriber is going to be,” Kinnear says. “Is it going to be the parents, the grandparents? Are you going to set up an RESP for your niece or nephew? My general recommendation is, so long as the parents are reasonably financially sound, it's usually best to have the parents be the subscribers, just because it's a lot easier to administer.”
Not only do parents typically have the best visibility into the child’s education and financial needs, but older subscribers can often come with estate planning issues. If, for example, the grandparents are serving as subscribers, they need to know that if the RESP money is not used for a child’s education, then a penalty tax of 20 per cent, as well as income tax will have to be paid on that money. The only way to avoid that tax is to fold the RESP money into an RRSP, but the grandparent of a 21-year-old child is very likely already past the age where they can contribute to RRSPs.
While the cost of traditional university education has become a hot topic lately, many younger people are electing to forego that cost in favour of a shorter, cheaper, technical school program. Should they make that choice, they may end up using less of the RESP savings than were initially accumulated. Educational assistance payments from an RESP, Kinnear notes, tend to be drawn from growth in the account as well as education bonds. While that money typically gets put towards tuition, textbooks, and incidental costs, Kinnear notes that wider applications like living costs can be covered with cash from the RESP.
If there’s still money left over in that child’s account, she notes that a sibling or even a cousin could qualify for the extra cash depending on the nature of the plan. For subscribers trying to dispose of any cash left over, Kinnear notes that RESPs typically expire 35 years after they were created and have to be disposed of by that time. Disposal outside of inclusion in an RRSP can come with tax bills.
While some young people may elect to choose a shorter, cheaper program, others will pursue graduate education and what parents might have thought was a four-year plan suddenly turns into six, eight, or ten. Despite that possibility, Kinnear argues that erring on the side of a shorter education may prove more tax advantageous for the subscriber.
There are a host of estate planning considerations that an advisor can introduce into the RESP conversation as well. Kinnear notes that often times RESP subscribers will not make specific plans for those funds in their wills. Instead there will be standard distributions to a spouse and then to all their surviving children equally. For a grandparent with multiple children, one grandchild, and an RESP for that grandchild there can be some significant estate planning headaches that emerge. Advisors with RESP subscriber clients may want to have explicit conversations about what they want done with the RESP in the event of their death or loss of capacity, and if there are any restrictions or intentions they have for the money in the long-term.
The issue of educational choice points to an inherent tension that advisors have to navigate in using RESPs and planning for education costs. Parents may plan for their child’s education with their advisor from an early stage in the child’s life, but as that child grows, they gain agency and the desire to possibly pursue a different and unexpected educational path that comes with a different cost than what the parents initially planned for. Kinnear reframes that tension as an opportunity for advisors to include the next generation in the planning process, engage them on conversations about how their education will be funded, and impart financial literacy lessons along the way.
“Advisors can ask the parents if the child even knows that this RESP exists, whether they talked with their child about how education is going to be funded, and maybe open it up to talk about investment planning,” Kinnear says.
