Chapter 16: The Registered Education Savings Plan (RESP)
Attending post-secondary school is becoming more common each year. Similarly, the costs of an education are increasing. To finance further schooling, many are relying on support from family or student loans. The cost of repaying student loans can challenge the financial well-being of a new grad. This can cause unwanted pressure to pursue a career that may provide immediately without offering future growth. As a result, any savings provided by family to pay for post-secondary education are very valuable.
A Registered Education Savings Plan (RESP) is, in most cases, the best way to do just this. The account allows you to make the most of any money put aside for a loved one’s post-secondary education. In the simplest of RESP accounts, there are two people to consider: the creator of the account, called the subscriber, and the person the account is for, called the beneficiary. For example, if you’re opening an account for your child’s education, you’d be the subscriber and your child would be the beneficiary. The first step is for you, the subscriber, to open the account and start making deposits.
There are several RESP options available depending on your needs. For instance, joint accounts allow for multiple subscribers, so you and a spouse could deposit. In addition, there’s family or group accounts that allow for multiple beneficiaries. Depending on your plans for the account and personal situation, there can be minor advantages to each account type. However, for our purposes, we’ll focus on an individual account with one subscriber and one beneficiary.
RESP Benefits
There are two main attractions to the RESP that make it such a great savings product for education purposes. The first is that money grows tax free while it remains in the account. The second is the government grant and incentive programs that deposit additional money in the account.
Tax-Free Growth
Because money in an RESP grows tax free, it compounds at a faster rate. Then, once the growth is withdrawn, it’s typically taxed at a low rate, if at all. In most cases, the withdrawal is referred to as an Educational Assistance Payment (EAP). These are withdrawals made to help the beneficiary pay for school. They’re classified as income to the beneficiary. In most cases, the beneficiary has limited income while in school and, therefore, pays little if any tax on the withdrawals.
Government Incentives
In addition to tax-free growth, there are several grants and incentives offered by federal and provincial governments. Some of these grants are available to everyone, while others are only available to lower-income families. For simplicity, we’ll focus on the two primary incentives that are offered by the federal government.
The Canada Education Savings Grant (CESG)
The first grant we’ll discuss is the Canada Education Savings Grant (CESG). It matches 20% of your deposits to an RESP. Like the RRSP and TFSA, there are rules around when and how much you can contribute to the account. These include:
The beneficiary accumulates $500 in potential grant matching each year.
The grant will pay a maximum of $1,000 to the account in any one year.
The grant will pay a maximum of $7,200 to the beneficiary in total.
The maximum you can contribute to the account is $50,000.
Like employer retirement plans in Chapter 11, the accelerating power of matching is hard to pass up. By making a deposit to the RESP, you receive an immediate return of 20%. This is the equivalent of three years’ growth at 6%.
In 2005, the CESG was expanded through the introduction of the Additional CESG. This was done to help middle- and low-income families reach their education savings goals more easily. The Additional CESG provides an extra 10% or 20% matching of the first $500 in contributions each year. Therefore, a qualifying beneficiary could receive an additional $100 a year deposited to their account. The Additional CESG counts toward the beneficiary’s total lifetime limit of $7,200.
The Canada Learning Bond (CLB)
The second incentive is the Canada Learning Bond (CLB). It provides up to $2,000 for qualifying beneficiaries without requiring any contributions to the RESP. As a result, opening an RESP for a qualifying beneficiary can provide financial support without any obligation on the subscriber.
The CLB is slightly different than the CESG since it doesn’t require any contributions to the RESP. Instead, it has other qualifying rules. To be eligible, the beneficiary must:
be from a low-income household
have been born on or after January 1, 2004
be a resident of Canada
have a valid SIN
be named on an RESP
The first year they’re eligible, the beneficiary receives $500 to the account. They also receive $100 each additional year they qualify, up to and including the year they turn fifteen. Therefore, a beneficiary that receives $500 the first year and $100 for the next fifteen years would receive the full $2,000.
Using the Account
The following example focuses on the two most common benefits of the RESP, the CESG and tax-deferred growth. A mother opens an RESP for her two-year-old daughter. Each year since birth, her daughter has accumulated $500 in potential grant matching, even though she didn’t have an account. Therefore, the daughter has a total of $1,500 in potential matching when the account is opened. The mother starts off with an initial deposit of $2,000. This deposit is met with a 20% match of $400 by the CESG.
Every year from her daughter’s third to seventeenth birthday, the mother contributes $1,000 to the RESP. Each contribution is matched with a $200 grant. Assuming an annual return of 5% for fifteen years, the account would reach a value of $30,900. The balance of the account would be $17,000 in contributions from the mother, $3,400 in CESG and $10,500 in growth. The two main benefits of the RESP are the $3,400 in grants and $10,500 in growth, which has compounded tax free so far.
RESP Withdrawals
With an RESP created and funded, it’s time to see how money is withdrawn. Since contributions to the RESP have already been taxed, they’re not taxed when withdrawn. These contributions can be paid to either the beneficiary or subscriber. If the beneficiary is attending a qualifying or specified educational program, these withdrawals don’t impact grants. In this case, a Post-Secondary Education (PSE) withdrawal is made. Both the grants and earnings collected throughout the life of the account can be withdrawn as EAPs. As we mentioned, these are taxable income to the beneficiary in the year they’re withdrawn. In our previous example, the contributions totaled $17,000 and could be withdrawn with no taxes. Meanwhile, the $3,400 plus the $10,500 would be withdrawn as EAPs and taxable to the beneficiary.
Exhibit 41 – If the beneficiary attends a qualifying or specified educational program, the following flow of money applies.
Without Post-Secondary School
The intention of the RESP is for the money to help the beneficiary attend a post-secondary education. However, if the beneficiary doesn’t pursue this route, there are still benefits to the RESP. The CESG contributions may be rolled over to a sibling in certain situations. Otherwise, these must be returned to the government since they were intended to pay for schooling. Your contributions can be withdrawn tax free. Any growth in the account, called Accumulated Income Payment (AIP), may be handled in one of two ways. Once certain requirements have been met, the AIP can be withdrawn and taxed as income plus an additional 20% tax. Or, again, provided certain conditions are met, the AIP can be rolled into an RRSP account.
Final Thoughts
The benefits of contributing to an RESP for education savings are substantial. The rules for contributing to an RESP and the grants you may qualify for may change over time. Additional information on opening, funding and using an account can be found online. You can find it on the Government of Canada’s website or through any local financial institution that offers RESP accounts.
Key Takeaways
Grant matching on deposits and tax advantages help your money for post-secondary schooling go further.
You may qualify to receive money from the government without having to make deposits yourself.
Complexities of the RESP make it worth learning more when you’re ready to use the account.
This blog is a duplicate of the recently self-published book The Snowman’s Guide to Personal Finance available for purchase here.