RESP (Registered Education Savings Plan): Key Facts and Investment Tips

The Registered Education Savings Plan (RESP) is a great tool to help people fulfill the most taxing responsibility in the world, raising a child. Having a newborn child isn’t easy. It is a challenge to even plan for the next week. Planning for the newborn’s college education seems even more difficult. College fees are very high and it isn’t very easy to attend them. However, the Canadian Government offers a RESPite to parents. Here’s what you need to know about this awesome tool.

RESP (Registered Education Savings Plan): All You Need to Know

What is an RESP?

As the name suggests, a Registered Education Savings Plan is nothing but an investment account geared towards saving for a child’s education. Like its tax-shelter cousins the RRSP* and TFSA*, an RESP allows investments inside the account to grow tax free, meaning no taxes on capital gains and no income taxes on interest and dividend payments. The biggest advantage of RESPs is the fact that the government gives you an incentive by paying an additional grant of up to $7,200 over the plan’s duration.

How does an RESP work?

The sponsor of the plan, usually the child’s parent or guardian, makes a contribution to the RESP. The government then ponies up 20% of that, up to a maximum contribution of $2,500 each year. If you contribute the maximum amount, you basically get $500 in free money from the government. Known as the Canadian Education Savings Grant (CESG) this government money goes straight into the beneficiary’s RESP and is yours to invest as you please.

The additional grant amounts benefit lower and middle income families a lot. In case the child’s family’s income falls below $45,916, the government pays an extra 20% on the first $500 contributed, upto a total grant of 40%. For families with income below $91,831, an extra 10% is paid by the government, adding up to a total grant of 30%. The $7,200 lifetime grant limit is still applicable.

You don’t have to necessarily contribute $2,500 a year to get the full government grant. Put in what you can. Any unused grant room is carried forward and can be used in future years. The only caveat is that in any one year the maximum grant that can be claimed is $1,000.

Why should you open an RESP?

There are many reasons for opening an RESP for a child. Here are just 5:

  1. Post-secondary education is only getting more expensive. The average tuition for a four-year undergrad university program in Canada is now $27,300, and that doesn’t include accommodation and food, let alone other expenses.  As part of the Maclean’s university guide, the magazine estimates the total annual cost of post-secondary education to be close to $20,000—or $80,000 over four years.
  2. Yes, it’s possible to save for a child’s education with just your TFSA. But if you do that, you will miss out on the grants the government kicks into your child’s RESP.
  3. Your money contributed to the RESP grows tax free.
  4. When your child starts receiving payments from the RESP for school, the money will be taxed at their income, and since students are famously broke, their tax bill will be low.
  5. RESPs have long lifespans. Even if your child doesn’t want to go to school right away, you can use the RESP money later. RESP accounts can remain open for 36 years, giving kids plenty of time to come around.

How to  open an RESP?

Simple. The easiest approach is to contact your bank, credit union, online broker, financial planner or robo-advisor and ask them to open a self-directed RESP account. You’ll require some valid documentation, like your social insurance number, your child’s SIN number and your child’s birth certificate.

Once you open the account, remember to set up an automatic monthly withdrawal from your checking account towards your RESP. In order to receive the highest possible grant, set the withdrawal to at least $208.33. However, even something as small as $25 adds up.

A lot of RESP providers offer a wide range of services and fees. Some companies offer group or pooled RESP accounts. These accounts usually carry quite a few restrictions on the contribution and withdrawal and money. The fees tend to be on the higher side as we. The simplest, low cost option is always the self directed RESP.

To encourage more families to sign up for RESPs, in 2018 the Ontario government bolstered its infant registration system for new parents so that along with registering for things like a birth certificate and social insurance number, new parents can choose to be referred to an RESP provider. Other provinces are looking at similar programs.

What if you have more than one child?

In such a scenario, you can open an RESP family plan. They work like individual accounts, with the same contribution limits per child, but all the children can benefit in the savings and the costs of this type of plan are lower than opening multiple individual accounts. Every beneficiary must be under 21 years old and should be related by blood or through official adoption.

Is there a contribution limit to RESP?

There’s no annual limit on how much you can put into a child’s RESP but there is a lifetime contribution limit of $50,000. So if you wanted you could put that full $50,000 into the RESP as soon as it’s opened and grow that investment tax-free. But if you do that, be aware that you’ll only get a CESG grant on the first $2,500 of that amount. You’ll end up forgoing a minimum of $6,700 of government money.

The lifetime contribution limit is also something to keep in mind if there are more than one RESP accounts opened for a child—for instance, if both the parents and grandparents open RESPs in the child’s name.

If you go over the $50,000 limit you’ll be penalized by the Canada Revenue Agency with a tax of 1% per month on the excess money until it’s withdrawn.

How to get the RESP government grant?

RESP providers usually apply for a CESG grant on your behalf automatically. A lot of institutions notify the government about the contributions monthly. In return, it might take six to eight weeks for the grant to start showing in your account. However, some RESP providers only apply for the grants once or twice a year. Make sure to ask your provider how often the grants will be deposited.

How cn you invest an RESP

RESPs have the ability to hold the same investments as an RRSP or TFSA, such as cash, stocks, bonds, GICs, and mutual funds, not to mention foreign investments. But there are strategies to consider. In the child’s early years you might look at taking more risks with a higher share of the portfolio in equities. A low-cost mutual fund or ETF would help with that. Then as your child ages and gets closer to needing the money, lower the RESP’s exposure to equities. You can also look at a laddered GIC, especially once the rates rise. The most important thing in the end is keeping it simple.

How are RESPs taxed?

The money in your RESP grows without any tax levied on them, similar to an RRSP or TFSA, with some key differences. For one, unlike an RRSP, you don’t receive a tax refund when you contribute to an RESP. In that way, they’re like TFSAs.

However, there is a tax that has to be paid when money is withdrawn from an RESP, so in that regard, they’re like RRSPs.

Once your child starts in a post-secondary program there are two types of RESP withdrawals, and they are taxed differently.

The money you yourself contribute to an RESP can be withdrawn tax-free as Post-Secondary Education payments. On the other hand, the portion of the RESP that came from government grants, as well as any capital gains and investment income, is withdrawn as Educational Assistance Payments (EAPs) and is taxable as income. However, it’s taxed in your child’s hands. Students usually have low to no income, they should end up not paying any tax. Since you are allowed to specify the type of withdrawal you want to make, draw down the EAP portion first. That way if your child doesn’t finish the program or there’s money left over, contributions will make up a larger portion of what’s left and can be taken out by you tax free.

What if your child doesn’t go to school?

In case your child decides to forgo school/university or pursue any of the other qualifying programs like apprenticeships or trade schools, you have options. In case you have invested in a family plan, you can transfer the amount to another child (up to a $7,200 lifetime grant limit).

The original contribution to the RESP can be withdrawn tax-free, so if you maxed out your contributions, that’s $50,000 you can withdraw without penalty. All grant money must be returned to the government. All the other elements of the RESP,  the capital gains and income from dividends and interest, are returned to you in the form of an Accumulated Income Payment (AIP). This payment is taxed in the year you receive it and is subject to an additional 20% penalty.

You can choose to avoid this tax hit by transferring this sum (up to a maximum of $50,000 to your RRSP. To do this, the child must be over the age of 21 and the RESP must have been open for at least 10 years. You will also need to have sufficient room in your RRSP. If you don’t, you can delay withdrawing the AIP until some room becomes available.

So that was a brief look at the Registered Education Savings Plan (RESP). It is a pretty useful investment tool to help secure your child’s higher education. Do try and start investing a little in it in case you aren’t already.

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