All parents strive to provide the very best for their children. They are devoted to creating a life even better than they have experienced. That is just the natural instinct of a caring, loving parent.
The vast majority of parents realize how important providing a great education is today and how it dramatically impacts their children’s lives. However, most parents do not commit financially to their children’s education. This is unfortunate considering the advantages Canadians have for providing this sought-after benefit. What is worse is that many parents who have saving for their children’s education are not utilizing the very best tool available to maximize their efforts: the Registered Education Savings Plan (RESP).
What is an RESP?
The RESP is an education savings program for Canadians. It is a tax shelter similar to an RSP and TFSA in which subscribers are able to capitalize on education grants both federally and provincially where applicable.
What is required to set up an RESP account?
You simply need a Social Insurance Number and identification for both the subscriber and the contributor, as well as a Canadian bank account. Basic personal and financial information is also obtained and may vary slightly from one institution to another.
What are the benefits?
Every dollar contributed to an RESP up to $2,500 per year is eligible to receive a grant from the federal government. Many provinces also provide additional subsidies as well. (For example, in Saskatchewan, RESP savings receive an additional 10 percent on top of the federal amount per year!)
These Canadian Education Savings Grants (CESGs) provide an immediate minimum 20 percent return on your money regardless of what you choose to invest in, which is very significant. It equates to an extra $500 per year on a $2,500 annual contribution. The dollars definitely add up.
Here is description of the benefits provided for each family income bracket:
40% for families earning < $43,953
30% for families earning < $87,907
20% for families earning more than $87,907
Note that unused CESG room can be carried forward, and each child qualifies for a lifetime maximum benefit of $7,200.
What are the investment options inside an RESP?
You can invest in various types of investments from GICs, mutual funds, exchange traded funds (ETFs), stocks, bonds, etc. There are also organized pools, groups and scholarship trusts, although they are typically loaded with restrictions and additional fees. These types of plans are usually sold at trade shows and aggressively marketed to young parents without much transparency. The most flexible option is to set up a traditional RESP with a financial institution in which you control the amount you would like to contribute both initially and over time. RESPs also give you the best flexibility should your child not decide to attend post-secondary education.
Which post-secondary institutions qualify?
Although the variety and amount of institutions have increased dramatically over the years, it is important to learn which institutions qualify for RESP eligibility. They include many universities, trade schools, etc., however, we always advise our contributors to investigate the options that feel suitable to them personally.
What if my child is unable or chooses not to pursue post-secondary education?
There are a couple different options available:
1. You can transfer your RESP to your RRSP without incurring any taxation as the subscriber as long as the subscriber has enough eligible RRSP contribution room. You will sacrifice the CESG portion from your contributions, but will not have to pay any tax on any of the investment growth upon transfer to the RRSP.
2. You can withdraw the money from the RESP and it is tax in the hands of the subscriber. Again, you forfeit the CESG that has been obtained since inception.
How are RESPs taxed upon withdrawal by a child beneficiary?
The child who receives the RESP will pay income tax on every dollar withdrawn. But, because the child receiving the benefit will most likely have very low income, if any, they’ll pay only a fraction of the tax you would otherwise expect to pay on the investment earnings. Also, most tuition expenses provide a full tax credit, therefore, it is very common for most students to pay no income tax at all upon withdrawal.
What are the maximum contribution limits for an RESP?
There is no annual limit, but there is a lifetime maximum of $50,000 per child that can be contributed in their name. It equates to just under $2,777 a year or $231 a month over 18 years. If exceeded, the subscriber would pay a 1 percent per month tax on the excess contributions.
CESG money does not count towards this lifetime maximum. Theoretically you could contribute the maximum amount, receive 20 percent per year in CESG benefits and, with a 6 percent return, would grow the RESP account to over $125,000 by the time your child turns 18.
What if I have more than one child?
Families with two or more children we advise to set up what is called a family RESP plan. The same contribution rules apply, but you can name more than one beneficiary as long as they are under 21 years old when they are added to the plan.
Who can be a contributor or subscriber of the plan?
It is very common for grandparents and step-parents to wish to contribute to an RESP on behalf of a child. There are no restrictions to whom can subscribe to an RESP plan for a child.
It's common for parents to become overwhelmed by the various rules and details surrounding education savings plans.
We advise our clients to focus on the simple fact that contributing to an RESP plan is both lucrative and flexible for both the contributor and the child. The key component is that each dollar invested receives an immediate minimum 20 percent return which is hard to beat under any circumstance, especially during today’s market and interest rate environment.
Try not to focus so much on the analysis of what type of investment strategy to implement at first, and simply aim to open an account and make contributions for your child as quickly as possible. Even a lower returning asset such as GICs or high-interest savings will grow significantly with the effect of the additional grant being deposited to your account.
As always, we invite you to contact us should you have any questions or would like to further explore the options available to you in maximizing the education savings for those most special to you.