Recently I have had a few discussions with clients about transferring wealth to the next generation, specifically the best way to provide financial assistance to their kids and grandkids. Transferring wealth to family members is generous and is a common goal. However when transferring to grandchildren, who are often minors, income attribution rules might apply. Additional planning is needed to avoid these tax hiccups.
One common solution is to help pay for the grandchild’s education. This can be accomplished with a Registered Education Savings Plan (RESP). A RESP is a tax-deferred investment vehicle that helps save for a child’s (or grandchild’s) post-secondary education. Unlike an RRSP, contributions to the plan are not tax deductible. However, similar to an RRSP, investment income is not taxable until funds are withdrawn from the plan. There is a $50,000 lifetime contribution limit. One of the big benefits of using an RESP is the Canadian Education Savings Grant (CESG). With the CESG the government will match 20% of your contribution up to a lifetime maximum of $7,200 per child. The CESG is one of the reasons using an RESP is a great way to transfer wealth. Not only do the grandkids have money set aside for education the government kicks in 20%!
There are a few wrinkles. If the grandchildren do not pursue post-secondary education the plan will eventually have to be wound down. If this situation occurs, the government will take the CESG back. Your contributions will be returned to you; however any growth that has accumulated on the investments will be taxed. In fact the growth will be taxed at your normal income tax rate plus an extra 20%. The only way to avoid the 20% penalty is to roll the money into your RRSP. After the age of 71 you are not allowed to add to your RRSP. Often by the time the grandchildren are old enough to decide whether or not they will attend post-secondary school, the grandparents are over 71. So if the grandchildren do not pursue post-secondary, money you intended to help your family will likely be returned to you with an extra tax burden.
A creative solution is to have your kids be the contributors to the RESP. You gift the money to your children and they contribute it to an RESP with the grandchildren as beneficiaries. The 20% CESG will still be added to the account and the grandkids will still have money set aside for their education. However if the grandkids decide post-secondary school is not for them, the original contribution is returned to the contributors, in this case your kids, and the growth (which attracts that ugly 20% tax penalty) can be rolled into your kids’ RRSP.
By listing the children as contributors and the grandchildren as beneficiaries the money has effectively been transferred to the next generation, the government adds a 20% grant and you avoid any tax penalties.
This article provides a high level overview of using an RESP as a tool for intergenerational wealth transfer. There are additional details that need to be considered, it is best to consult your tax and estate professionals before implementing this strategy.
This information transmitted is intended to provide general guidance on matters of interest for the personal use of the reader who accepts full responsibility for its use, and is not to be considered a definitive analysis of the law and factual situation of any particular individual or entity. As such, it should not be used as a substitute for consultation with a professional accounting, tax, legal or other professional advisor. This commentary reflects my opinions alone, and may not reflect the views of National Bank Financial Group.