Investing for Children: RESP or In-Trust For Account?

Suppose parents or grandparents want to set aside money for a child. Or suppose a minor child (under age 18 or 19 depending on the province) receives a significant inheritance, or has part-time or summer job earnings that you think should be put away to grow, perhaps for higher education or an eventual house purchase.

The money will be safe in a bank account but not earning much. GICs are also safe but grow slowly. If the intended spending is many years away, investing is an attractive option but there is a problem – legal restrictions prevent minors from opening an investment account in their own name.

Two options may provide a solution. Both are typically available at discount brokerages. The new TFSA is not an option since only those 18 and over can have one in their name.

Registered Education Savings Plan (RESP)

This is a special plan created by the Government of Canada to assist savings for post-secondary education by allowing tax-free growth inside the plan and by providing extra grants, the Canada Education Savings Grant (CESG) for everyone and the Canada Learning Bond for lower income families.

Informal Trust aka In-Trust For – (ITF) Account

In such an account, a parent or other adult acts as trustee to manage investments on behalf of the child, who becomes legally entitled to take over at the age of majority. In this type of account, there is no restriction for how or when the funds may be withdrawn and spent.

There are many important differences between RESPs and ITFs in terms of control, ownership, flexibility, grant availability and especially taxation, some of the key ones of which are summarized in the chart below. RESPs and ITFs are essentially equal when it comes to investing itself as all types of stocks and bonds are allowed in both and in allowing virtually anyone to contribute.

Assuming that the possibility of further education is a goal and other things being equal, my take on how RESPs and ITFs shake out are this:

  • it is worth contributing enough to the RESP to get the full government grant money, which means making contributions over a period of years, instead of all at once
  • if there is enough money, put the max CESG amount in the RESP and the rest in an ITF
  • to keep things simple, parent or grand-parent money should go into the RESP before it goes into the ITF
  • put the child’s own money into an ITF; in this case, the tax attribution complexity doesn’t arise; there will be no taxes for the child to pay unless the sum to invest is very large and produces more than the basic personal tax-free allowance in income every year (e.g. in 2009 the personal allowance is $10,320, which is equivalent to 6% on $172,000)

How an RESP works

The subscriber (or a person acting for the subscriber) generally makes contributions to the RESP. Subscribers cannot deduct their contributions from their income on their tax return. If not paid out to the beneficiary, the contributions are usually paid by the promoter to the subscriber at the end of the contract. Subscribers do not have to include the contributions in their income when they get them back.

The promoter usually pays the contributions to the beneficiaries. Income earned on the contributions is paid to the beneficiaries in the form of educational assistance payments (EAPs). Beneficiaries include the EAPs, but not the contributions, in their income for the year in which they receive them from the RESP.

The Canada Revenue Agency registers the education savings plan contract as an RESP, and lifetime limits are set by the Income Tax Act on the amount that can be contributed for each beneficiary. Unless the RESP is a specified plan the RESP must provide that no contributions (except transfers from another RESP) may be made to the plan at any time after the end of the year that includes the 31st anniversary of the opening of the plan. Furthermore the plan has to be completed by the end of the year that includes the 35th anniversary of the opening of the plan, unless it is a specified plan.

Here is an overview of how an RESP generally works.

  1. A subscriber enters into an RESP contract with the promoter and names one or more beneficiaries under the plan.
  2. The subscriber makes contributions to the RESP. Government grants (if applicable) will be paid to the RESP. These grants can be the Canada Education Savings Grant, Canada Learning Bond, or any designated provincial education savings program.
  3. The promoter of the RESP administers all amounts paid into the RESP. As long as the income stays in the RESP, it is not taxable. The promoter also makes sure payments from the RESP are made according to the terms of the RESP.
  4. The promoter can return the subscriber’s contributions tax-free.
  5. The promoter can make payments to the beneficiary to help finance his or her post-secondary education.
  6. The promoter can make accumulated income payments.

A registered education savings plan (RESP) is a contract between an individual who is the subscriber, and a person or organization, who is the promoter. The subscriber (or a person acting for the subscriber) makes contributions to the RESP, which earns income. The subscriber names one or more beneficiaries and agrees to make contributions for them.

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