How we save for our kid’s education using tax deferred savings accounts and tips on how to save while considering the family budget.
We were fortunate to receive monetary gifts for Bibi when she was born. We decided to start saving for her future education costs with those generous gifts. When it comes to saving for college, the earlier you begin the more money you can save.
Below I’ll share some of the options for college savings plans that I found when I was researching for Bibi. Please remember to consult with your own accountant or financial planner when making these decisions.
It is important to remember that you might not be in a position to save for college right now. That is okay! You could start a savings fund and share that information with grandparents and relatives who ask for alternative gift ideas.
Ways to Invest in Canada – RESP
In Canada, the RESP (Registered Education Savings Plan), is one of the most popular ways to invest in a child’s education. The RESP provides a tax-sheltered registered account for post-secondary education savings.
An added benefit of this account is that your child might qualify for government contributions. The Canada Education Savings Grant (CESG), Canada Learning Bond (CLB), and other government incentives can add or match money you have contributed to the RESP.
As long as the income stays in the RESP account, it is not taxable. You can contribute any amount to an RESP, subject to a lifetime contribution limit of $50,000 per child (as of 2022). Contributions can be made for up to 31 years. The RESP can remain open for a maximum of 35 years.
Your child receives the funds from the RESP with proof of enrollment in a qualified post-secondary education or training program. You can withdraw initial after-tax contributions paid into the plan tax-free. However, the student must claim “Educational Assistance Payments” as income on their tax return.
These EPAs consists of “accumulated income” (money that you earned in your plan as interest), grants and bonds. EPAs are taxed at your regular income tax level, plus an additional 20 percent. However, most students usually have little or no income during the time of withdrawal. The the tax implications are usually lower.
As mentioned above, the government will make contributions into your RESP through the CESG (Canada Education Savings Grant). They will match 20% of any RESP contributions up to $2,500 per account child per year. That’s a maximum of $500 per year for each child. Lower income families can receive an additional contribution through the Canada Learning Bond. For 2021, that’s less than or equal to $49,020 adjusted net family income for families with 1-3 kids.
You can name multiple beneficiaries (with “blood relationship”) on the Family RESP Plan. We chose this type of plan for Bibi. The benefit of family accounts is the ability to allocate different amounts to each child depending on their schooling needs. You can learn more about the 3 different types of accounts here. Ours is a self-directed investment account in one of Canada’s Big Five Banks. This allows us to invest in ETFs and stocks. (RESP accounts can invest in mutual funds, ETFs, GICs, stocks, bonds.) We selected a combination of “safer” long-term stocks with good dividend yields and Canadian ETFs.
Helpful links for Canadian Parents:
Information About RESPs – Government of Canada
RESP Calculator – BMO
What happens if you contribute the lifetime RESP maximum as a lump sum?
Canada Education Savings Grant – Government of Canada
Canada Learning Bond for Lower Income Families- Government of Canada
Choosing the right Registered Education Savings Plan (RESP)
Ways to Invest in United States
There are several options for saving money for college in a tax advantaged way in the U.S.
529 College Savings Plan
The most common choice is a 529 college savings plan. These are savings plans sponsored by states, state agencies, and educational institutions. Each plan has different investment options. You can choose to put your money in any state’s plan, not just the state in which you live.
Once you put money into a 529 Plan, you select which investment option you are comfortable with. There are choices depending on your child’s age, several static options and a few customized options. All of the investment options are a “unique mix of [investment] funds” designed to help the money in your child’s account grow.
Account earnings in a 529 Plan accumulate tax-deferred. Earnings used for qualified higher education expenses are not subject to federal or state tax. Some (but not all) of these expenses including tuition, computers, books and room and board. Several state 529 plans that allow up to $10,000 to be withdrawn for qualified K-12 tuition expenses.
Be sure to research the available 529 Plans to determine the best one for your child. You can find their investment options and typical rates of return in detail on their websites. Some states offer significant tax benefits to their residents.
Anyone can contribute to your child’s 529 Plan. One drawback of 529 Plans is that they can have a negative impact on your child’s ability to receive federal financial aid for college. Below are a few posts which might help you create a better savings structure to set your child up in a better position when they apply for financial aid: Don’t let that 529 college plan hurt your financial aid, Does a 529 Plan Affect Financial Aid?
Coverdell Education Savings Account (ESA)
Another way to save for your child’s education in the US is a Coverdell Education Savings Account or ESA. An ESA has tax advantages similar to a 529 account. You don’t have to pay taxes on income or capital gains when you invest in an ESA. This helps the money compound faster. When money is withdrawn for qualified education expenses, withdrawals from an ESA are not taxed.
A Coverdell ESA is different from a 529 in several ways. The money CAN be withdrawn for qualified education expenses from kindergarten through college. Additionally, ESAs have more investment options.
An ESA does have drawbacks. Unlike the 529 accounts, there is an income eligibility limit for contributors. There is a cap of $2,000 per year per beneficiary. That amount is potentially lower based on your Modified Adjusted Gross Income.
The good news is that you can invest in both a 529 savings plan and an ESA for your child.
Helpful Links for American Parents:
An Introduction to 529 Savings Plan- Securities and Exchange Commission of US Government
ESAs and other Custodial Accounts-FINRA (Financial INdustry Regulatory Authority)
Internal Revenue Service (IRS) Tax Benefits for Education
Thorough 529 Plan Comparison Tool from SavingforCollege.com
Tips for Choosing College Savings Plans-FINRA
Saving for College is Easier than you Think-Dave Ramsey
Start Early to Take Advantage of Compound Interest
Starting to save for your child’s education early will allow you to take advantage of compound interest. When you invest or save money, you earn interest. If the interest is reinvested, it is called compound interest. Compound interest is a powerful way to make your savings or investment grow rapidly.
For example, in the investment scenario I created using the BMO RESP Investment Calculator, saving $2500 per year as soon as your baby is born will give you a projected savings of $77,602.52 when the child is 18. If you begin investing five years later, the savings result is dramatically different. Assuming a 4% rate of return, added CESG at the end of the year and interest added the following year, the total projected savings would only be $51,543.20. This is a difference of $26,059.32 of which only $12,500 is the initial contribution ($2500/year X 5 years), the rest is gains from interest.
I really enjoyed this article. It shows the outcome of four imaginary scenarios with the same contribution amount invested at different stages of a child’s life. This illustrates the benefits of contributing a larger lump sum in the beginning. Investing early will result in greater gains through the growth of investments over time. It is a better choice than relying on the guaranteed grants by the government.
Tips for Saving With Simple Habits
When you have young children, finding extra money to put into their college savings can feel like a monumental task. Through simple habits and smart choices you can find dollars here and there to invest in your child’s eduction. Here are some ideas for you.
- Borrow/Buy Used/Re-sell: When you need something, first, try to borrow it. Second, look on Craigslist or Facebook Marketplace and buy used. Third, after you are done with an item, sell it.
- Reduce and Refocus Spending: Look for one or two small components of your budget that you could eliminate or tighten up in order to direct that money towards savings. This can include reducing one restaurant visit a month, making snacks instead of buying pre-made, borrow books from the library instead of buying etc.
- Involve your family and friends: If friends or family ask for gift ideas, give them the opportunity to contribute all or part of their gift amount towards your child’s education.
- Donate as part of your gift: Kids get so many presents already. As parents, we can choose to dedicate their gift money to their education savings accounts. One easy and enjoyable way to do this is to give the gift of an experience and save the rest for education contributions.
- Earmark Bonus Money: Make the choice ahead of time to put any “bonus” money (tax refunds, tips, holiday bonus etc.) into education savings.
- Start a Side Hustle: There are so many different side hustle options available nowadays. You can dedicate a few hours each week or month to a side hustle with a primary focus on earning money for your child’s education. Some ideas include freelance work, virtual assistant, blogging, handyman repairs, Etsy shop, driver for Uber, Lyft, or UberEats. Those extra dollars will add up quickly.
- Make it Automatic: Set up automatic contributions to education accounts each month. Then you don’t have to make the decision each month because it is automatic. Suddenly, saving for college is a simple habit.
- Learn and research: Be open and curious about alternative ways to save for your child’s education. Here is an article which outlines different financial solutions beyond investing in a traditional education savings accounts.
- Involve your Kids: Get kids excited and involved in saving for their education. You can set family goals to save certain amounts for college. It also helps if you are open about the costs of higher education. Additionally, explaining scholarships and helping your child set educational and activity goals, they will be better positioned for future scholarships.
Time is one of the best tools available for saving up for your child’s education. With creative budgeting, research and thoughtful choices you can begin putting money toward’s your child’s education while they are young.
I hope these ideas will encourage and inspire you to find a way to begin a educational savings account for your child. Knowing that we are helping Bibi get closer to college bit by bit is very rewarding.