Should you open your child an RRSP?
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Should you open a child RRSP in Canada? It is possible, but this tax-sheltered investment vehicle may not be the best way to save for your child’s future.
When parents consider saving money for their children, they usually think of opening a Registered Education Savings Plan (RESP), which helps create an education fund for a child. Or they might even consider a Tax-Free Savings Account (TFSA) – a flexible, tax-sheltered way to save money for the future. But what about RRSPs? A child RRSP in Canada is often left out of the conversation, but sometimes an RRSP can be a good way to save for your child’s future. Keep reading to find out whether opening an RRSP for your child is a good idea.
Can I open an RRSP for my child?
Yes, you can open a child RRSP in Canada. A minor can set up an RRSP with the consent of their parent or legal guardian. But your child must have a job and must have earned an income and gotten a T4 from their employer in the previous tax year. So if your child is still in diapers, an RRSP is likely not an option. But if they are in their teens and working and paying income tax, then yes, you can open an RRSP for them. However, there are some things to consider before taking the leap.
Should I open an RRSP for my child?
There are a few good reasons to open an RRSP for your child:
- To promote healthy habits: If you want your child to learn to save money, an RRSP is a good choice.
- To buy a house: With soaring home prices, buying a house is a hurdle for the next generation. But your child can get a head start by contributing to their RRSP and then take advantage of the Home Buyers’ Plan later in life.
- Investing early: Your child can also take advantage of the magic of compound interest by investing early. For example, if your child starts working at age 14 and invests $100 per month, they’ll end up with a much larger nest egg by age 65 than someone who starts investing the same amount at age 30. The comparison chart below illustrates the benefits.
Downsides to opening an RRSP for a child
These sound like great reasons, but there are also several downsides to opening an RRSP for your child:
- RRSP withdrawals will be taxed. So if your child needs the money for college or a car, a TFSA might be a better choice if they’re 18 years old or older. Likewise, consider opening an RESP instead of an RRSP, because you’ll get the added value of the Canada Education Savings Grant (CESG).
- The tax benefit derived from RRSP contributions may be small or non-existent. If your child earned $12,000 at a part-time job and contributed the maximum RRSP contribution amount of 18% of their gross income or $2,160, their contributions wouldn’t give them the benefit of a reduction in income tax owing, because they aren’t paying any tax anyway. It’s a bit of a waste – you want to save the tax benefits of an RRSP for your high-earning income years.
- Not all financial institutions will open an RRSP for a minor. For instance, most robo-advisors and online brokerages in Canada do not allow minors to open RRSPs, even with parental permission. While legal to open an RRSP for a child in Canada, it’s simply against their company policy. So if you’re dead set on doing it, you will have to do some research to find the right institution.
Can I use my RRSP for my child’s education?
Canada’s Lifelong Learning Plan lets you withdraw up to $10,000 per year tax-free, with a lifetime maximum of $20,000 per person. You’ll repay the money over 15 years, any money that you don’t repay during that time is subject to income tax. This program is available to you and your spouse, but it is not available for children. If you want to use your RRSP money to pay for your child’s education, you’ll need to withdraw the money and pay tax on it.
How to open an RRSP for your child
If you’ve decided that opening an RRSP for your child is the right step, here’s what your child needs:
- Income: Your child must have earned an income, been issued a T4 by their employer (an allowance won’t count) in the previous year and filed an income tax return. Earning an income creates contribution room, which will be equal to 18% of the previous year’s earned income.
- Consent: Your child must have a letter of consent from a parent or legal guardian.
The process of opening an RRSP for your child is otherwise very similar to opening one for yourself, including the process of deciding what to do with the contributions.
Alternatives to an RRSP for your child
Depending on your financial goals for your child, an RRSP isn’t always the right choice. Here are some alternatives to opening an RRSP for your child.
If your child is 18 years or older, they can open a Tax-Free Savings Account (TFSA). As the name suggests, money contributed to a TFSA will grow tax-free. Withdrawals are not subject to extra tax withholding, and unlike RESPs or RRSPs, they can withdraw the money for any purpose, at any time.
However, to unlock the full power of the TFSA, we recommend opening a TFSA investing account once your child reaches the age of majority in your province. If you use the TFSA to invest in long-term equities, you can gain a better return in the long run. A high-interest savings account might only give a measly 1 or 2%, whereas you could snag 7-8% from a balanced index ETF portfolio.
If you’re comfortable with DIY investing, you could invest your child’s TFSA contributions yourself using a discount brokerage. Otherwise known as an “online brokerage,” it’s an excellent option for DIY investors who want the flexibility to build their own portfolio and skip paying the high fees attached to actively managed funds.
A discount brokerage like Questrade or Wealthsimple Trade does require some knowledge of investing, so if you’d rather take a more hands-off approach while getting the lowest fees possible, you could opt to invest your child’s TFSA money with a robo-advisor. A robo-advisor will use a questionnaire to determine your risk tolerance and automatically build a portfolio to suit your needs, and their fees are much lower than mutual funds – meaning you’ll get an even better return on investment.
READ MORE: The best TFSA investment options in Canada
If you want to set up an education fund in Canada, a Registered Education Savings Plan is an excellent choice. You can contribute up to a lifetime maximum of $50,000 per child, and your contributions will grow tax-free. If your child is under 17, the federal government and some provincial governments will also put money into your child’s RESP, matching 20% of your contributions up to a maximum of $500 per year. That works out to a whopping $7,200 lifetime maximum (a year’s tuition!), and this amount can be even higher for low-income families.
Setting up an RESP is simple. If you’re a DIY investor, set up a pre-authorized contribution plan to your discount brokerage account so you invest consistently. We recommend Questrade because you get the benefit of the lowest fees possible along with $50 in free trades when you start investing with Questrade. You must fund your new account with a min. of $1,000.
If you don’t feel confident managing your own investment portfolio, there are a number of excellent robo-advisors in Canada that will invest on your behalf. All you need to do is open an RESP and set up automatic contributions, and they’ll take care of the rest. For the RESP, your CESG disbursements will be automatically deposited into the account and invested on your behalf.
READ MORE: A guide to RESPs
If your child has a job and earned an income in the previous tax year, they can open an RRSP and make contributions to it. An RRSP can be a good option to help your child establish the healthy habit of saving, get ahead on their retirement nest egg, or to help them save for a house. That said, if your child plans to use that money to pay tuition, put a down payment on a car, or pay off debt, there are more appropriate investment options, such as an RESP or TFSA.
READ MORE: RESP vs. RRSP: Which to choose?