Registered Education Savings Plans (RESP) are powerful tools for parents to secure their children’s educational future. Like other ‘registered’ accounts provided by the government, an RESP has numerous tax advantages that can significantly impact the child’s post secondary choice.
RESPs provide important tax advantages. While contributions are not tax-deductible, all earnings within the plan are tax-sheltered. This means that interest, dividends, and capital gains grow tax-free within the account.
Let’s follow along Sonia and Tara’s example to better understand an RESP
Sonia opens an RESP for Tara, her 6-month old daughter. She opens the RESP and is told about the generous incentive, namely the Canada Education Savings Grant (CESG), which provides up to 20% of the contribution to an RESP, to a maximum of $500 per year. The maximum grant money Tara can receive over her lifetime is $7,200.
Sonia decides to take advantage of the CESG and contribute $2,500 annually, in order to receive $500 in tax free money. There is no annual contribution limit on the RESP but since the grant maximum is $500 annually, it is better to spread out her contributions to receive it every year.
Let’s see how Tara can benefit from her RESP
- Tax-deferred growth – Sonia’s contributions are not tax-deductible but any capital gains, interest or dividends are tax-deferred. Since Sonia does not incur any taxes on the growth or income on the RESP, the funds can accumulate faster. If Sonia invests $2,500 each year for the next 17 years (and the $500 grant is deposited each year), the RESP will grow to $81,266 (average return of 5%).
- Tax-advantaged withdrawals – At the time of withdrawal, any gains and grants received are taxable to the beneficiary, not the RESP sponsor. So, when Tara starts withdrawing the money, she will owe taxes on the growth and grants, but since she will be a student with little to no income, and will have deductions related to her tuition, it’s unlikely she will pay any tax.
- Flexibility on expense type – Tara can use the RESP for a variety of eligible expenses. The money is hers to use, whether she decides to enroll in a university or a trade school. Aside from tuition, she can also use the money to pay for books, tools, transportation and rent. That’s a great feature because student housing can add up quickly. For instance, student housing for fall and winter terms 2024 is approximately $10,000, not including meals. Sonia’s savings can help her daughter in ways that suit them both.
- Availability of education grants – Tara needs to have an RESP to avail of the various federal and provincial grants offered to fund post secondary education. In her case, she has been receiving the $500 annually until the age of 17. She would not have received this money without an RESP.
- Additional benefits for lower income households – Low-income families qualify for a higher CESG – Up to $600 or $700 annually, depending on household income. Additionally, parents who receive the Canada Child Benefit, can also receive up to $2,000 more over the child’s lifetime through the Canada Learning Bond (CLB) even without any RESP contributions.
- Time horizon –Unlike other registered accounts like an RRSP, an RESP does not require immediate withdrawals after a certain age. It can remain open for 36 years, so Tara need not decide a career path immediately. While Tara will not receive the CESG grant after the age of 17, Sonia can still contribute until Tara is 20 years old and let the investments grow. If she continues investing her $2,500 until Tara is 20, the money grows to $102,351 at an average rate of 5%.
While RESPs have many advantages, you should be aware of their limitations too:
- Penalties for overcontribution – While there is no annual contribution limit, the lifetime limit is $50,000. If Sonia overcontributes to the RESP she will be taxed on the excess amount at a monthly rate of 1%, and will be required to withdraw it to avoid further penalties.
- Eligibility of grants – Like most grants, eligibility for the Canada Learning Bond is based on the household income and number of children, so only lower income families qualify. The Canada Education Savings Grant is capped at $7,200 for each beneficiary and requires repayment if a child has received more, so you need to track the amount received.
- Death of subscriber – If Sonia dies without a will, the RESP will be collapsed as part of Sonia’s estate, be subject to taxes and probate fees and distributed to all the beneficiaries in her will. To ensure that Tara receives the RESP money, Sonia should either appoint a joint subscriber or a successor subscriber who can ensure that Tara can receive the funds when she wants to.
- Unused RESPs – If RESP funds are not used for education, the subscriber can transfer them to their other registered plans, with certain conditions. In Sonia’s case, she has the option of transferring her original RESP contributions and up to $50,000 of earnings tax-free to her RRSP. However, she will have to return the grants received from the government.
Keep these limitations in mind and plan strategically to build up your child’s education fund. For children born in 2024 or later, the government will automatically open an RESP for them. That will ensure the kids have access to grant money, as long as the parents make the annual contribution.
Contact us to learn more about RESPs and other concepts to ensure your financial wellbeing!