Students pursuing a post-secondary education have a lot in common with retirees: they have various income sources to piece together to meet after-tax expenses for a particular time horizon.
Yet while retirement planning is a fixture in our industry, planning for students is much less common. This is likely because students lack assets and income. However, advisors should focus on future potential. After graduation, students transition to decades of potential income and asset growth. Their grandparents and parents won’t be clients forever, and those former students will inherit potentially large sums. You shouldn’t leave relationship building with beneficiaries until the eleventh hour.
You can build relationships with students now by demonstrating the value of financial planning.
Advisors often meet students through their parents or grandparents, who have set up a registered education savings plan (RESP) for them. When students and their families start looking for their annual educational assistance payments (EAPs), you can take an immediate need and expand it into a multi-generational planning opportunity.
Maximizing after-tax income
With most retirees, planning focuses on tax-efficient investments and pension income-splitting to maximize after-tax income while preserving income-tested benefits like old age security. For students, the focus can be on tax credits and deductions.
EAPs aren’t the only source of taxable income for students. There’s also employment, investment income and various scholarships or bursaries. If expenses (which can include tuition and books, room and board, computers and more) are greater than income, the gap is likely filled by student loans.
Generally, non-refundable tax credits save tax at the lowest marginal tax rate at both the federal and provincial level. However, if the student has no taxes payable, non-refundable credits that can’t be carried forward are lost. Beyond the basic personal amount, students may be eligible for the Canada employment amount, a tax credit for interest paid on eligible student loans, and the tuition amount. The first two can’t be carried forward, whereas the last two can be.
Most refundable tax credits can be paid out regardless of the student’s taxes owing. Some examples are the GST/HST credit, the working income tax credit, the Canada training credit, and child and family benefits. Refundable credits are income-tested, so the lower the student’s taxable income, the higher the dollar value they receive.
Finally, tax deductions reduce taxable income, but only some can be carried forward. For students with children, child-care expenses are an example of a deduction that can’t be carried forward. Such deductions should be used to their fullest when available. Other deductions, like the one for eligible moving expenses, can be carried forward. Ideally, these deductions should be taken in years where income is higher.
Where does this leave advisors? Remember why the family came to you in the first place: to discuss their EAP withdrawal.
EAP from RESP
An EAP includes government incentives and investment earnings on RESP assets. They are taxable to the student beneficiary. There is a withdrawal cap of $5,000 ($2,500 for part-time students) for EAPs taken in the first 13 weeks of enrolment. Beyond this, the annual EAP withdrawal threshold is $20,000, indexed to inflation ($24,676 for 2021). Amounts paid above this annual limit require an assessment for eligibility. Finally, EAPs can be taken up to six months after enrolment ceases.
By maximizing EAPs through the student’s studies, you reduce the amount in the RESP that would be a future non-educational payment — the accumulated income payment (AIP). The AIP is taxable to the RESP subscriber (the person who set up the account), who would pay tax at their marginal tax rate plus 20% unless they transfer the AIP to their RRSP, an RDSP for the student (if eligible) or pay it to a designated educational institution. Finally, if an AIP is requested, grants and bond must be fully repaid to the government.
With some planning, students can maximize their EAP withdrawals, ensuring all government incentives go to their education. This can include forecasting the years of study, annual expenses and the total RESP assets. By integrating this with their other income sources, you can help them utilize available tax credits and deductions, making RESP withdrawals as tax-efficient as possible. And by maximizing after-tax income now when it’s needed, you can reduce the student’s need to take on debt, positioning them well for their prime earning years.
Curtis Davis, FCSI, RRC, CFP, is senior consultant for tax, retirement and estate planning services, retail markets at Manulife Investment Management.