Country Routes - June, 1998

Much has been written about the new advantages of a RESP with the Canadian Education Savings Grant of 20% on the first $2,000 to a maximum of $400 per year. But, of course there are restrictions, namely that the money has to be used for post-secondary education only. The other major problem is, there is no provision to receive tax-deductibilty for contributions to the plan.

What most financial planners have suggested in place of a RESP is an informal In-Trust account which is usually better because of the flexibility it offers. Funds are not restricted soley for post-secondary education. If an equity-based mutual fund is used, capital gains are taxed in the child's name. However, annual distributions will be taxed in the parent's hands. This is usually nominal with little effect on the taxes paid. And of course if the child does not go on to post-secondary education, all of the growth is still your money as opposed to only receiving your contributions in a RESP. However, a provision was made available where RESP earnings can be transferred to your RRSP. In addition, the CESG of 20% must be repaid.

How about another method that I have not heard discussed before? By contributing to your Spouse's RRSP you get the tax credit and deductiblity of your contributions. Income splitting is another reason to open a spousal RRSP. The spouse (the contributor) with the higher income opens a plan in other spouse‘s name(the annuitant).

You can contribute up to the maximum you would be allowed if you were contributing to your own plan, $13500 or 18% of your annual income or your the amount shown on your previous year's tax assessment notice. The contributor get the tax deduction now and when it comes time to withdraw the funds, the funds are taxed at the spouse's with the lower income tax rate. If the funds are withdrawn from the plan within 3 years of the contribution, the amount is added to the current year's income of the contributor and taxed at the contributors current tax rate.

Now here comes the creative part of how to take the money out in less than two years tax-free up to the limits of the personal deduction if the spouse has no income. This is done by shortening the three-year spousal rule. Here is how to do that. You see, the three-year rule is based on the calendar year. That means that the individual who contributes money to a spousal RRSP on the last day of February 1998 will get credit on their 1997 tax return. Because they have to wait until the first day of 2000 before they remove the money, they have really only kept their money in a spousal RRSP for 22 months instead of the required 36. This can now be used for any purpose including post-secondary education.

If you can arrange not to make any further contributions as stated above, then this may be a helpful strategy to help fund your child's post- secondary education and get full tax-deductibilty for your contributions. This should more than compensate for the CESG benefit without the restrictions. You will have more flexibility using a spousal RRSP in this way. It would also be advantageous, if the higher income earner was to become unemployed. The funds could be withdrawn and be taxed when the contributor's income was lower.

With the rules changing with each new budget, it is a good idea to seek the advise of a financial planner or an accountant to work out the pros and cons of income splitting, especially as you approach retirement age and will be eligible for the O.A.S.

If you have any questions, please call Reg Borrow at (519)855-6639. He is an Independent Financial Consultant for Regal Capital Planners since 1983.