Using a trust to pay for your children’s education expenses is an excellent tool to minimize taxes through income splitting. It is particularly useful for parents who want to provide financial support for their children’s post-secondary education expenses. A family trust can be used by business owners, professionals and self-employed persons to save taxes through income splitting with family members. To use a family trust in this fashion, you need to operate your business activities through a corporation. Active business income earned by your corporation is taxed at a very low rate (in British Columbia, the first $500,000 of active business income is taxed at only 13.5%).
Dividends are a way to distribute after tax profits. If a family trust is a shareholder of your corporation, the corporation can pay dividends to the family trust. The family trust can then allocate dividends to you or any of your family members who are beneficiaries of your family trust. Suppose that you have a daughter who is 18 years old and is about to enter into her first year of university. She will be attending a university in another city and you would like to provide her with some financial assistance. You have determined that you are prepared to provide financial assistance of $20,000 per year for her tuition fees, books and materials, travel and living expenses. She will be a full-time student and will not have any other income. If you simply chose to pay that $20,000 yourself, you would need to withdraw approximately $30,000 of dividends from your corporation. If you earn $130,000 or more per year, you are in the top tax bracket. Your tax rate on dividends in British Columbia would be 33.71% (the rate for dividends on active business income that is taxed at the low corporate rate of 13.5%). On the $30,000 dividend, you would pay approximately $10,000 in taxes leaving you with a net of $20,000 after tax. You would use this to pay for your daughter’s education expenses. On the other hand, if your daughter was a beneficiary of your family trust, the trust could allocate $20,000 of dividend income directly to her. Since your daughter has no other income, as a result of the dividend tax credit, she would pay absolutely no tax on this dividend. She could then use this $20,000 of dividend income for her education expenses. This results in a savings of approximately $10,000 per year, and for a 4-year degree, this would amount to a $40,000 tax savings.
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You may also wish to establish a Registered Education Savings Plan (RESP) to save for your daughter’s post-secondary education. The RESP provides two main advantages: You may be entitled to a 20% Canada Education Savings Grant up to a maximum of $500 per year.