In recent years, I’ve been getting a lot of questions about the Registered Education Savings Plan which is more commonly known as RESP. I suppose I shouldn’t be that surprised that many of my peers are interested in the RESP rules since they’ve just had children. Heck, one of the first things I did when my daughter was born was to set up her RESP.
Basically, an RESP is a a type of account that can be used to help you save for your child’s education. As an added incentive, the government gives you an RESP grant of 20% of your contributions. There’s also some tax benefits which is why an RESP is the best way to save for your child’s post secondary education.
When it comes to setting up your RESP, there are some basic rules you’ll want to understand.
- An RESP can be set up for any “beneficiary” including your children, grandchildren, or family friends
- The beneficiary must be a Canadian resident and have a Social Insurance Number
- There’s a lifetime RESP maximum of $50,000 per beneficiary
- You can get a 20% match up to $500 per year thanks to the CESG
- You can contribute to an RESP up to 31 years and the plan can remain open for a maximum of 35 years
- An RESP can hold a variety of investments including mutual funds, ETFs, stocks, bonds and GICs
- Capital gains are tax-free while it is in your RESP
- You do not get a tax refund for RESP contributions
- Money withdrawn from the RESP as an Educational Assistance Payment is taxed in the hands of the beneficiary
Although some people think the RESP rules can be complicated, as you can see from above, it’s pretty straightforward. I realize some of you may still be confused, but I’m going to breakdown things even further so you really understand how RESPs work.
Types of RESP in Canada
When I refer to the types of RESP, what I mean is the type of plan you get create or setup. These are the three types of RESPs in Canada you need to know about:
Non-Family Plan – When setting up an RESP for their first child, most people opt for the non-family plan. By doing this, the RESP is managed for the individual child. What’s nice about this option is you can set your investments to line up with the timeline of the beneficiary without having to worry about your choices affecting any other beneficiaries.
Family Plan – Some parents like family plans since it allows multiple beneficiaries as long as they’re related by blood or adoption by the subscriber (the person who setup the RESP). With this type of plan, you’re dealing with one big pot of money so you can allocate funds as needed. However, since you’ll have multiple children in the plan, you may need to be more conservative with your investments.
Group Plan – In my opinion, group plans should be avoided. They’re attractive since they can give your children a defined payout, but there are so many conditions and rules that there’s no guarantee you’ll get what you were promised. Seriously, if you google RESP group plans in Canada, you’ll probably quickly find many horror stories.
RESP investment options
As mentioned above, your RESP is basically an investment vehicle which allows you to put a variety of investments within the account such as:
- Mutual funds
Since this is for your child, many people think investments that aren’t risky are the way to go. That’s a good thought, but if you set up your child’s RESP when they’re born, it’ll be 16-18 years before they need that money. That’s plenty of time to grow your child’s RESP so you have a balanced portfolio to reflect that time line.
Do-it-yourself investors won’t have an issue with this, but people who are new to investing may be a bit terrified about all of this. As a result, most investment firms have a mutual fund option which automatically re-balances the portfolio based on your child’s estimated first year of their post-secondary education. This is a decent option, but the management expense fee is typically 2.5% or higher which is quite expensive.
Another (and likely better) option is to use a robo-advisor that does the same thing but charges much lower fees. I like Justwealth’s RESP portfolios since they use target dates but charge much lower fees compared to many other financial institutions. Clients will be charged the minimum monthly fee of $2.50 per month OR the 0.5% annual fee (never both), whichever one is greater. To help you get started, you’ll get $50 for free when you open an RESP with Justwealth via my referral link.
Canadian Education Savings Grant (CESG)
What really makes an RESP appealing is the RESP grant which is formally known as the Canadian Education Savings Grant or CESG. This grant gives the beneficiary a 20% match up to $500 per year. That means if you contribute $2,500 per year to your child’s RESP, you’ll get another $500 for free. Alternatively, if you contributed $2,000, your child would get $400.
The government realizes that you may not have $2,500 just lying around every year so they allow you to carry the grant over for one year. In other words, you can skip contributions one year and then make a deposit of $5,000 the next year and still get the full $1,000 CESG grant ($500 X 2). As you’ve probably guessed, you can’t contribute $25,000 one year and then expect to get 10 years worth of RESP grants.
Keep in mind that there’s a lifetime CESG grant of $7,200 up to the age of 18 so your child could reach that limit when he or she is 14 if you opened an RESP the year they were born.
RESP grant for lower income families
As an added incentive, lower income families can get up to an additional $100 each year from the CESG. Families with a household income under $45,916 get a 40% match on the first $500 in RESP contributions and then 20% on all contributions up to $2,500. That would give them a yearly RESP grant of $600
If your household income falls between $45,917 and $91,831, then your beneficiary would get a 30% match on the first $500 contributed to their RESP. All other contributions up to $2,500 earn you a 20% match. Families in this circumstance would get a total of $550 per year from the CESG.
Note that the income brackets change yearly based on the adjusted family net income level shown on your tax return for the previous tax year. Regardless of your income, the lifetime CESG limit is $7,200.
RESP Withdrawal rules
When your child is ready to make RESP withdrawals, there are two scenarios to consider:
When the funds are used for their education – Upon enrollment of a qualifying post-secondary school, you can withdraw funds from the RESP as long as you can provide proof of enrollment. Any payments made including the grand and/or bonds are referred to Educational Assistance Payments (EAPs) which the student must claim as income when they file their taxes. Since most students will have little to no income, the money withdrawn from their RESP is usually tax-free.
When the funds are withdrawn and not used for education – If your child decides not to continue their education, you can still withdraw your initial contributions without having to pay any taxes. That being said, any interest and capital gains (known as accumulated income) will be taxed at your income level, plus another 20%.
In addition, you can transfer the CESG from the child who is not continuing their education to a brother or sister if they have grant room available. If this isn’t an option, the CESG and any bonds must be returned to the government.
When you finally close the RESP, you can reduce the amount of taxes you pay by transferring your accumulated income (up to $50,000) to your or your spouse’s RRSP. This is only possible if you have enough contribution room. For more details on what happens to unused RESP? Check out this post.
If you want to help your child with their post-secondary education, there’s no better way than setting up an RESP. The 20% match you get from the CESG is free money and it’s guaranteed! Even if your child decides not to continue their education, you won’t lose the money you initially contributed. Use my Justwealth referral link now and get $50 when you open an RESP with them.