What is an RESP?
Registered Education Savings Plans (RESP) are a great way to accumulate money which can be used to pay for children’s post-secondary education costs. They are a special type of account which you can set up with a financial institution, into which you can make regular or lump sum contributions.
You do not get a tax deduction for the money you put into an RESP. But there is a generous benefit that the Canadian government gives to RESP contributors. It is known as the Canada Education Savings Grant (CESG). Each year, the CESG provides 20% of the Registered Education Savings Plan (RESP) contributions of up to $2,500. That means the CESG can add a maximum of $500 to an RESP each year.
The lifetime limit on contributions is $50,000 per child. The RESP contributions can be invested in a balanced portfolio of stocks and bonds. For example, contribute $2,500 per year for each child by putting in a little over $100 every two weeks for 14 years. Over those years you would have contributed $35,000 and the government grants would total $7,200 – for a total of $42,200. But with the money invested and earning an average annual rate of 6%, the account would grow to nearly $70,000.
Neither the contributions, the CESG grant, nor the investment income earned within the RESP will be taxed until money is taken out to pay for your child’s education. Even then, money paid out of the RESP for educational purposes is taxed in the hands of the student. Since many students have little or no other income, they can usually withdraw the money tax-free or at a very low tax rate.
Even though the RESP offers such attractive incentives to save for children’s future education costs, Statistics Canada estimates nearly 50% of Canadian parents are not taking advantage of RESPs. So these families are not maximizing the potential and leaving money on the table.
Who can contribute to an RESP?
Usually, it’s the parents who open up an RESP and name their children as a beneficiary, but in fact anyone can open up an RESP – uncles, grandparents, and so on. If you open an RESP and contribute money, you are known as a “subscriber”. Funds which are contributed remain the property of the subscriber until the money is withdrawn by the student.
Who can withdraw from an RESP?
The student chooses when to withdraw funds from an RESP and in what amount. As mentioned earlier, these withdrawals are taxable income to the student. If there is money left over, an individual or family RESP can stay open for 36 years so if your child doesn’t continue his/her education, you can keep the plan open in case they decide to resume studies later. If your child is unlikely to pursue post-secondary education or all the funds in the plan are not required, you may be able to transfer up to $50,000 tax-free to your RRSP (if you have available contribution room) so long as the RESP has been open for at least 10 years and all beneficiaries are at least 21 and not currently pursuing higher education.
Next Steps?
Like all investment strategies, making an early commitment and sticking to it is the best plan, so as to benefit from the annual tax-free compounding of returns. Many families aren’t aware how much money they are leaving on the table each year in missed CESG payments. The earlier an RESP is established, the better.
About Me
Lisa Ko, Licensed Insurance Advisor – I have been helping my clients for more than 10 years with their personal financial needs, including RRSP’s, RESP’s, TFSA’s and non-registered investments. I also work with companies and individuals to help them deal with life risks through insurance products and employment benefit plans.
