I recall the story a few years ago of Doug Anglin who, at the age of 17, filed a complaint with the U.S. Department of Education against his Massachusetts high school. Mr. Anglin’s complaint was that the school was discriminating against boys by giving better grades to students who “sit down, follow orders, and listen.” According to Mr. Anglin, men naturally rebel against this.
While students can face challenges in achieving good grades, parents face challenges paying for education. Two of the biggest problems for parents are that (1) they have to use after-tax dollars to pay for education, making it expensive, and (2) the cost of private elementary or high school tuition is not eligible for tax credits.
Today, I want to share some ideas on how to pay for education – whether elementary, high school or post-secondary – and to do so using pretax dollars. That is, using dollars that you have earned that have not, and may not, be subject to tax. Here are three ideas to consider.
Consider Peter and Janice. They live in British Columbia and have four children. Their eldest daughter is heading to university this fall. Peter earns about $100,000 annually, and figures they’ll need $15,000 to help cover the cost of tuition, books, supplies, and room and board for their daughter this school year. At a marginal tax rate of 38.3 per cent, Peter would have to earn $24,311 (almost one quarter of his salary) just to be left with $15,000 after taxes to help pay for his daughter’s education.
Janice carries on a part-time business. She decided last spring that she’ll try to earn enough to pay the $15,000 toward their daughter’s education. Janice has had their daughter working in the business as well. In fact, Janice will pay her daughter the $15,000 – reasonable wages for the work performed – that she needs for school. The result? Janice gets a tax deduction for the $15,000 that will be used by their daughter to pay for school, and their daughter will pay no tax on the income because she has a basic personal tax credit that will offset the first $11,138 of income from tax federally, and she has tuition, education, and textbook tax credits to offset the rest. The bottom line is that the family will use pretax dollars to pay for the cost of school.
Aaron and Vonnie have three children who will be attending a local private school again this year. A trust was established for the kids a few years ago with $300,000 provided by Aaron’s parents, with Aaron and Vonnie as trustees (they control the funds in the trust). The funds are being invested in a portfolio of securities, earning income and capital growth. The trust earns about 6 per cent – about $18,000 – in income and growth annually.
The interest and dividend income earned in the trust on the original $300,000 is attributed back to (and taxed in the hands of) Aaron’s parents each year under the attribution rules in our tax law. But the income on the income (second-generation income), and all capital gains, are taxed each year in the hands of the children. The minors each have a basic personal tax credit available which more than offsets any tax owing on the income allocated to each of them each year. The bottom line? It’s expected that a few thousand dollars (perhaps between $5,000 and $10,000) will have been earned, but not taxed, thanks to the kids’ basic personal tax credits in 2014. These dollars can be used to help fund the education costs of the kids.
Rachel and Eldon have two young children, and they’re setting aside $200 each month ($2,400 annually) in a registered education savings plan (RESP) for the kids. In addition to their own contributions, the government is kicking in a Canada Education Savings Grant worth 20 per cent of their contributions – or $480 annually.
The funds inside the RESP grow on a tax-sheltered basis, and when payments are made to their children later in life, once they start to attend a qualifying postsecondary program, the income that had accumulated in the RESP will be taxed in the hands of the kids. The children will have their basic personal amount and tuition, education and textbook tax credits available at that time which could very well offset any tax owing. In effect, the accumulated income in the RESP can be used to fund education costs, potentially with little or no tax.
Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.