Registered Education Savings Plan (RESP)

What is an RESP?

RESPs are registered education savings plans that grow tax-free until the child is ready for university, college or a vocational institute. The student usually pays little or no tax on those funds when they are withdrawn at the student’s lower income tax rate.

What are the RESP contribution limits?

While there is no longer an annual RESP contribution limit, there is a lifetime contribution limit of $50,000 per child. The Canada Education Savings Grant of up to $7,200 is not included in calculating the lifetime RESP contribution limits.

The Canada Education Savings Grant is grant from the Government of Canada paid directly into an RESP that provides between 20 and 40 cents for every dollar saved for a child’s education (on the first $2500 saved each year), depending on your income. Only contributions to an RESP are eligible for the Canada Education Savings Grant. That’s a major plus along with earnings that grow tax-free until the child is ready for university, college or vocational school. There is usually little or no tax on those funds when they are withdrawn at the student’s lower income tax rate.

For example, if a family contributes $25 to an RESP every two weeks for a total of $650 per year, their RESP would receive a minimum Canada Education Savings Grant of $130, based on 20% of their total contributions.

If the family continues to contribute this amount each year for 15 years and we assume a very conservative 5% rate of return, the child would have $4,700 for each year of a four-year university program. Almost $800 a year would come directly from the grant.

The Amount of the CESG

The amount of the grant is based on your family income. The amount can change over time as your family income changes.

No matter what your net family income is, the grant provides at least 20 cents for every dollar on the first $2,000 of annual RESP savings made on behalf of a child.

  • Depending on your family income, your child could receive additional grant on RESP savings that you make after 2004 on behalf of a child:
  • If your net family income is below $37,178*, the grant will be 40 cents for every dollar on the first $500 you save in your child’s RESP each year.

If your net family income is between $37,178* and $74,357*, the grant will be 30 cents for every dollar on the first $500 you save in your child’s RESP each year.

Your net family income is reported on your Canada Child Tax Benefit statement (commonly known as “baby bonus”, or “family allowance”) that you receive from Canada Revenue Agency each July.

Over the past three federal budgets, the rules for RESPs have been changed to make them far more attractive to parents saving for their child’s education.

Some of the changes include the following:

  • Universities, colleges, CEGEPS, vocational and technical schools are now included as eligible post-secondary institutions.
  • The maximum contribution is now $5,000, increased from $4,000 and previously $2,000.
  • The lifetime limit on RESP contributions for one child is $50,000, up from $42,000.
  • There are more options for the parent if the child does not attend post-secondary school or does not complete the program. Previously a contributor could lose all the income earned by their RESP contributions if the child did not pursue a post-secondary education. That growth income stayed in the group plan for the benefit of students who did go on and complete their education. Only the original contributions would be returned to the parent.
  • Ottawa now allows RESP contributors to transfer up to $50,000 in interest earned in a registered education savings plan to their RRSP if they have sufficient contribution room.

Financial institutions offering RESPs are not required to include all of the changes proposed by the government. This means that RESP plans from different financial institutions may have different features, exclusions and limitations. Carefully review the different plans you are considering, and choose the one that meets your requirements.

What are the two types of RESPs available?

To keep it simple, for the moment: Scholarship Trust RESPs put your contributions into a pool with other contributors and invest it for you. Self-directed RESPs let you select your own investments from the company’s mutual funds or other investment choices. Plans can be set up for one child or several children in a family. We’ll cover the differences in more detail with a profile of each of the plan types.

Why is investing in an RESP better than saving outside an RESP?

According to the Federal Budget of 1998, saving inside an RESP with the Canada Education Savings Grant can create an education fund worth 40% more than saving outside an RESP.

A family saving outside an RESP could see their savings of $25 every two weeks over a 15-year period amount to $13,304 after tax, assuming a 5% market rate of return.

That same contribution, growing tax-free in an RESP, without a Canada Education Savings Grant, would total $15,666.

When the Canada Education Savings Grant is added to the RESP contributions each year, the total for those same contributions reaches $18,790. (Based on 20% of the total contributions.)

These rules are valid as of 2010.

When the child/beneficiary is ready to go to school the subscriber needs to start withdrawing money from the RESP account. To withdraw money you have to provide some proof to your RESP provider that the RESP beneficiary (child) is going to an approved post-secondary school. You don’t have to show receipts for specific purchases.

In your RESP account there are two different types of money: contributions and accumulated income. The contribution amount is the sum of all the contributions that you made to the account over the years. The accumulated income is made up of grants, capital gains, interest, dividends earned in the account. In other words any money that is not a contribution is considered to be accumulated income.

This distinction is important because the taxation of contribution withdrawals is different than accumulated income. Contribution withdrawals are not taxed since that money was already taxed when the subscriber first earned it. AIP (accumulated income payments) are taxed as income at the hands of the student.

The good news is that students have the personal exemption as well as tuition tax credits which helps lower their tax bill. Obviously income earned during summer jobs or on co-op work terms will affect their taxes as well. Another bit of good news is that you can tell your financial institution if you are with drawing contribution or AIP (or both) so you can manage the taxes to some degree.

First – one withdrawal rule to get out of the way – you are only allowed to withdraw $5,000 of accumulated income in the first 13 weeks. This is likely designed so a child who doesn’t want to go to post-secondary education won’t just sign up and attend one term in order to withdraw all the money in the RESP instead of the subscriber collapsing it properly.

When planning withdrawals try to withdraw as much accumulated income money as you can tax free. For example when the student first starts school, they will have just completed a short summer (two months) so they probably won’t have much income for the year. For the first year you should probably take the maximum AIP allowed in the first term of $5000 since it probably won’t be taxed at all. If the student is in a co-op program and has two work terms in one year and only one school term then that might be a good year to take out contributions rather than accumulated income.

A little tip – you might end up with too much money in the RESP especially if the child ends up going to school for shorter than expected. Just take out all the money when you can – if you leave it in the plan then you will have to collapse it and pay extra taxes on it.

What happens if Junior decides that school is not for him? You have to collapse the plan and pay a pile of tax on it. First of all you have lots of time to collapse the plan so don’t do it right away. It’s always possible that your child will give up on their pro hockey or musician career and will need the money for schooling later on.

If you do collapse the plan then the contributions are tax free, anything else (accumulated income) is added to the subscriber’s gross income for taxation purposes. And on top of that, the accumulated income is charged a tax of 20%.

Needless to say, if you are retired or have any way to reduce your income in the year you collapse a RESP plan, then do it to save taxes.

To get information on withdrawing money from your RESP, click here

For more information on RESP’s, contact our office.

RESP info courtesy of: Money Smarts